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An International Arbitrage Pricing Model with PPP Deviations

  • Levine, Ross

This paper derives an intertemporal, international arbitrage pricing model that relaxes more assumptions than previous asset pricing paradigms. The analysis shows how risk, risk premia, and the translation of these variables between all real and nominal numeraires depend upon a small number of stochastic state variables that define the economy's production and credit opportunities. When the model is applied to the forward exchange market, it highlights the potentially central role of real exchange rates in determining the evolution of forward exchange risk premia. Copyright 1989 by Oxford University Press.

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Article provided by Western Economic Association International in its journal Economic Inquiry.

Volume (Year): 27 (1989)
Issue (Month): 4 (October)
Pages: 587-99

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Handle: RePEc:oup:ecinqu:v:27:y:1989:i:4:p:587-99
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  1. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-87, September.
  2. Shanken, Jay, 1982. " The Arbitrage Pricing Theory: Is It Testable?," Journal of Finance, American Finance Association, vol. 37(5), pages 1129-40, December.
  3. 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.
  4. 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.
  5. 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.
  6. John F. O. Bilson, 1980. "The "Speculative Efficiency" Hypothesis," NBER Working Papers 0474, National Bureau of Economic Research, Inc.
  7. Hodrick, Robert J., 1981. "International asset pricing with time-varying risk premia," Journal of International Economics, Elsevier, vol. 11(4), pages 573-587, November.
  8. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November.
  9. 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.
  10. Domowitz, Ian & Hakkio, Craig S., 1985. "Conditional variance and the risk premium in the foreign exchange market," Journal of International Economics, Elsevier, vol. 19(1-2), pages 47-66, August.
  11. Cornell, Bradford, 1977. "Spot rates, forward rates and exchange market efficiency," Journal of Financial Economics, Elsevier, vol. 5(1), pages 55-65, August.
  12. 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.
  13. 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.
  14. Ross, Stephen A., 1976. "The arbitrage theory of capital asset pricing," Journal of Economic Theory, Elsevier, vol. 13(3), pages 341-360, December.
  15. 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.
  16. 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.
  17. 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.
  18. 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.
  19. 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.
  20. Solnik, Bruno H., 1974. "An equilibrium model of the international capital market," Journal of Economic Theory, Elsevier, vol. 8(4), pages 500-524, August.
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