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A Shadow Asset Pricing Approach to the Analysis of Financial Markets' Equilibria in an Open Economy

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  • Alexis Derviz

Abstract

The paper studies dynamic equilibria in international financial markets with consumption and portfolio optimizing agents. The arising stochastic dymanic optimization problems with state variable (in particular: liquidity) constraints are analyzed by means of the adjoint/Euler equation for the co-state process, as a part of the Stochastic Maximum Principle. In the problems under consideration, not so much the equilibrium asset holdings themselves, but rather their adjustment rates are of primary interest. This, and the fact that one must deal with state-variable-dependent utilities, leads to a situation where the traditional Consumption-based Capital Asset Pricing Model techniques do not work. Under these circumstances, the proposed adjoint equation method for the shadow asset prices (co-states of the optimization problem) provides new insights regarding the dynamics of equilibrium asset prices, particularly the exchange rate.

Suggested Citation

  • Alexis Derviz, 1996. "A Shadow Asset Pricing Approach to the Analysis of Financial Markets' Equilibria in an Open Economy," Bulletin of the Czech Econometric Society, The Czech Econometric Society, vol. 3(5).
  • Handle: RePEc:czx:journl:v:3:y:1996:i:5:id:32
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