An international arbitrage pricing model with PPP deviations
AbstractThis paper develops an intertemporal, international asset pricing model for use in applied theoretical and empirical research. An important feature of the model is that it incorporates both stochastic inflation rates and stochastic Purchasing Power Parity deviations (PPP). The model derives the equilibrium real return on assets, and obtains empirically tractable reduced form equations which can be used to examine such issues as capital market segmentation, currency substitution, exchange rate volatility, and the forward exchange market's risk premium. Mechanically, the model begins as a system of stochastic differential equations which describe the dynamic paths of a vector of state variables, prices, and PPP deviations. The state variables' intertemporal development determines the production and credit opportunities, and provides the model's fundamental dynamic nature. The model is shown to be consistent with the domestic-general equilibrium asset pricing models of Cox, Ingersoll, and Ross (1985) and Brock (1982). The model is applied to pricing forward exchange, and an empirically tractable equation of the risk premium is derived which will allow researchers to uncover the risk premium's economic determinants.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 294.
Date of creation: 1986
Date of revision:
Other versions of this item:
- Levine, Ross, 1989. "An International Arbitrage Pricing Model with PPP Deviations," Economic Inquiry, Western Economic Association International, vol. 27(4), pages 587-99, October.
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Stulz, Rene M, 1981. "On the Effects of Barriers to International Investment," Journal of Finance, American Finance Association, vol. 36(4), pages 923-34, September.
- Grauer, Frederick L. A. & Litzenberger, Robert H. & Stehle, Richard E., 1976. "Sharing rules and equilibrium in an international capital market under uncertainty," Journal of Financial Economics, Elsevier, vol. 3(3), pages 233-256, June.
- Cornell, Bradford, 1977. "Spot rates, forward rates and exchange market efficiency," Journal of Financial Economics, Elsevier, vol. 5(1), pages 55-65, August.
- Michael R. Darby, 1983. "Movements in Purchasing Power Parity: The Short and Long Runs," NBER Chapters, in: The International Transmission of Inflation, pages 462-477 National Bureau of Economic Research, Inc.
- Cho, D Chinhyung & Eun, Cheol S & Senbet, Lemma W, 1986. " International Arbitrage Pricing Theory: An Empirical Investigation," Journal of Finance, American Finance Association, vol. 41(2), pages 313-29, June.
- John F. O. Bilson, 1981.
"The "Speculative Efficiency" Hypothesis,"
NBER Working Papers
0474, National Bureau of Economic Research, Inc.
- Dybvig, Philip H & Ross, Stephen A, 1985. " Yes, the APT Is Testable," Journal of Finance, American Finance Association, vol. 40(4), pages 1173-88, September.
- Ross, Stephen A., 1976. "The arbitrage theory of capital asset pricing," Journal of Economic Theory, Elsevier, vol. 13(3), pages 341-360, December.
- Adler, Michael & Dumas, Bernard, 1983. " International Portfolio Choice and Corporation Finance: A Synthesis," Journal of Finance, American Finance Association, vol. 38(3), pages 925-84, June.
- Robert J. Hodrick & Sanjay Srivastava, 1983.
"An Investigation of Risk and Return in Forward Foreign Exchange,"
NBER Working Papers
1180, National Bureau of Economic Research, Inc.
- Hodrick, Robert J. & Srivastava, Sanjay, 1984. "An investigation of risk and return in forward foreign exchange," Journal of International Money and Finance, Elsevier, vol. 3(1), pages 5-29, April.
- Dhrymes, Phoebus J & Friend, Irwin & Gultekin, N Bulent, 1984. " A Critical Reexamination of the Empirical Evidence on the Arbitrage Pricing Theory," Journal of Finance, American Finance Association, vol. 39(2), pages 323-46, June.
- Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 335-359.
- Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-87, September.
- Breeden, Douglas T., 1979. "An intertemporal asset pricing model with stochastic consumption and investment opportunities," Journal of Financial Economics, Elsevier, vol. 7(3), pages 265-296, September.
- Solnik, Bruno H., 1974. "An equilibrium model of the international capital market," Journal of Economic Theory, Elsevier, vol. 8(4), pages 500-524, August.
- Hodrick, Robert J., 1981. "International asset pricing with time-varying risk premia," Journal of International Economics, Elsevier, vol. 11(4), pages 573-587, November.
- Shanken, Jay, 1982. " The Arbitrage Pricing Theory: Is It Testable?," Journal of Finance, American Finance Association, vol. 37(5), pages 1129-40, December.
- Korajczyk, Robert A, 1985. "The Pricing of Forward Contracts for Foreign Exchange," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 346-68, April.
- Levine, Ross, 1989.
"The pricing of forward exchange rates,"
Journal of International Money and Finance,
Elsevier, vol. 8(2), pages 163-179, June.
- Mika Vaihekoski, 2000. "Unconditional international asset pricing models: empirical tests," Finnish Economic Papers, Finnish Economic Association, vol. 13(2), pages 71-88, Autumn.
- Demirguc-Kunt, Ash & Levine, Ross, 1996.
"Stock Market Development and Financial Intermediaries: Stylized Facts,"
World Bank Economic Review,
World Bank Group, vol. 10(2), pages 291-321, May.
- Demirguc-Kunt, Asli & Levine, Ross, 1995. "Stock market development and financial intermediaries : stylized facts," Policy Research Working Paper Series 1462, The World Bank.
- Korajczyk, Robert A., 1995.
"A measure of stock market integration for developed and emerging markets,"
Policy Research Working Paper Series
1482, The World Bank.
- Korajczyk, Robert A, 1996. "A Measure of Stock Market Integration for Developed and Emerging Markets," World Bank Economic Review, World Bank Group, vol. 10(2), pages 267-89, May.
- Ng, David T., 2004.
"The international CAPM when expected returns are time-varying,"
Journal of International Money and Finance,
Elsevier, vol. 23(2), pages 189-230, March.
- Ng, David T.C., 2012. "The International CAPM When Expected Returns Are Time-Varying," Working Papers 127283, Cornell University, Department of Applied Economics and Management.
- Bernard Dumas, 1993. "Partial- Vs. General-Equilibrium Models of the International Capital Market," NBER Working Papers 4446, National Bureau of Economic Research, Inc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Kris Vajs).
If references are entirely missing, you can add them using this form.