Pricing Physical Assets Internationally: A Non Linear Heteroskedastic Process for Equilibrium Real Exchange Rates
Transferring physical capital and transferring production and sales activities from one country to the other, typically entails large adjustment costs. The model of this paper features two homogeneous stocks of physical capital located in two different countries, separated by an "ocean." The two physical stocks are optimally invested in a random production process yielding real returns, or consumed by local residents, or transferred abroad. Retro-fitting, transferring and re-building capital equipment, and increasing production and sales abroad either takes time (during which capital is idle) or consumes real resources. Under proportional transfer costs, trade imbalances, consumption imbalances and capital imbalances between the two locations are shown to be persistent. The stochastic process for the deviation from the Law of One Price (LOP) is obtained. By construction, this process is compatible with financial market efficiency and with the possibility of (costly) trade in commodities. Whereas empirical studies have found no evidence against the hypothesis that LOP deviations follow a martingale, the theoretical process which is found differs markedly from a martingale: the drift is non linear and mean reverting. But the behavior of the conditional variance more than offsets the reverting effect of the drift and the conditional probability of a move away from Parity is greater than the probability of a move toward Parity. When some price barriers are reached, however, reversion is triggered. We decompose the real-interest rate differential into an expected price change and a risk premium for which a very simple expression is found. The behaviors over time of the rate differential and of its components are examined.
To our knowledge, this item is not available for
download. To find whether it is available, there are three
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.
|Date of creation:|
|Date of revision:|
|Contact details of provider:|| Postal: |
Phone: (215) 898-7616
Fax: (215) 573-8084
Web page: http://finance.wharton.upenn.edu/~rlwctr/Email:
More information through EDIRC
When requesting a correction, please mention this item's handle: RePEc:fth:pennfi:25-89. 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: (Thomas Krichel)
If references are entirely missing, you can add them using this form.