IDEAS home Printed from https://ideas.repec.org/p/fip/fedgif/294.html
   My bibliography  Save this paper

An international arbitrage pricing model with PPP deviations

Author

Listed:
  • Ross Levine

Abstract

This 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.

Suggested Citation

  • Ross Levine, 1986. "An international arbitrage pricing model with PPP deviations," International Finance Discussion Papers 294, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgif:294
    as

    Download full text from publisher

    File URL: http://www.federalreserve.gov/pubs/ifdp/1986/294/default.htm
    Download Restriction: no

    File URL: http://www.federalreserve.gov/pubs/ifdp/1986/294/ifdp294.pdf
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. 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.
    2. Ross, Stephen A., 1976. "The arbitrage theory of capital asset pricing," Journal of Economic Theory, Elsevier, vol. 13(3), pages 341-360, December.
    3. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-887, September.
    4. 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.
    5. 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.
    6. Solnik, Bruno H., 1974. "An equilibrium model of the international capital market," Journal of Economic Theory, Elsevier, vol. 8(4), pages 500-524, August.
    7. Bilson, John F O, 1981. "The "Speculative Efficiency" Hypothesis," The Journal of Business, University of Chicago Press, vol. 54(3), pages 435-451, July.
    8. 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.
    9. Shanken, Jay, 1982. " The Arbitrage Pricing Theory: Is It Testable?," Journal of Finance, American Finance Association, vol. 37(5), pages 1129-1140, December.
    10. 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 313-329, June.
    11. 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.
    12. 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 323-346, June.
    13. Adler, Michael & Dumas, Bernard, 1983. " International Portfolio Choice and Corporation Finance: A Synthesis," Journal of Finance, American Finance Association, vol. 38(3), pages 925-984, June.
    14. Hodrick, Robert J., 1981. "International asset pricing with time-varying risk premia," Journal of International Economics, Elsevier, vol. 11(4), pages 573-587, November.
    15. Cornell, Bradford, 1977. "Spot rates, forward rates and exchange market efficiency," Journal of Financial Economics, Elsevier, vol. 5(1), pages 55-65, August.
    16. 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.
    17. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November.
    18. Stulz, Rene M, 1981. "On the Effects of Barriers to International Investment," Journal of Finance, American Finance Association, vol. 36(4), pages 923-934, September.
    19. Korajczyk, Robert A, 1985. "The Pricing of Forward Contracts for Foreign Exchange," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 346-368, April.
    20. Dybvig, Philip H & Ross, Stephen A, 1985. " Yes, the APT Is Testable," Journal of Finance, American Finance Association, vol. 40(4), pages 1173-1188, September.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. 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.
    2. 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 267-289, May.
    3. 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.
    4. Levine, Ross, 1989. "The pricing of forward exchange rates," Journal of International Money and Finance, Elsevier, vol. 8(2), pages 163-179, June.
    5. Mika Vaihekoski, 2000. "Unconditional international asset pricing models: empirical tests," Finnish Economic Papers, Finnish Economic Association, vol. 13(2), pages 71-88, Autumn.
    6. Bernard Dumas, 1993. "Partial- Vs. General-Equilibrium Models of the International Capital Market," NBER Working Papers 4446, National Bureau of Economic Research, Inc.

    More about this item

    Keywords

    Arbitrage ; Prices ; Foreign exchange;

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fip:fedgif:294. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Franz Osorio). General contact details of provider: http://edirc.repec.org/data/frbgvus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.