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Asset prices and exchange rates: a time dependent approach

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  • Giulia PICCILLO

Abstract

The paper studies the relationship between exchange rates and asset prices. It takes the approach of order ows to exchange rates. Specifically, it focuses on the effect of time-dependent risk aversion. The switch in the parameter causes the equilibrium of the system to alternate between two regimes: an optimistic and a pessimistic one. The paper is complete of a wide empirical section where the two equilibria are identified and specified for three of the main world markets. The regimes appear to be persistent and consistent with the existing literature on risk aversion. This also includes recent events of the financial crisis. The analysis uncovers a new development for exchange rate microstructure models. 3 of the 4 markets studied are consistent with both the order flow and the Markov switching models. The markets analyzed are the UK, Switzerland, Germany and Japan.

Suggested Citation

  • Giulia PICCILLO, 2008. "Asset prices and exchange rates: a time dependent approach," Working Papers of Department of Economics, Leuven ces09.02, KU Leuven, Faculty of Economics and Business (FEB), Department of Economics, Leuven.
    • Handle: RePEc:ete:ceswps:ces09.02
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    Keywords

    Exchange rates; Microstructure; Markov chains;
    All these keywords.

    JEL classification:

    • C2 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables
    • F3 - International Economics - - International Finance
    • G1 - Financial Economics - - General Financial Markets

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