Review of Financial Studies Vol. 31 No. 10 2018
Implications of Incomplete Markets for International Economies
Abstract
We develop a restriction that precludes implausibly high reward-for-risk in incomplete international economies to consider a theoretical problem that characterizes a lower bound on the covariance between stochastic discount factors (SDFs) subject to correct pricing. The problem is analytically solvable and synthesizes domestic and foreign SDFs into spanned and unspanned components. Our novelty is that exchange rate growth need not equal the ratio of SDFs and that the SDF correlations are plausibly lowered. Exploiting the realities of cross-country correlations of macroeconomic quantities, namely, consumption, wealth, dividend growths, and asset returns, our empirical investigation refutes the specification of complete markets. Received September 19, 2016; editorial decision August 31, 2017 by Editor Andrew Karolyi.
- DOI
- 10.1093/rfs/hhx120
- Volume
- 31
- Issue
- 10
- Pages
- 4017-4062
- Language
- en
- Sources
- bibtex:phds-export.bib crossref openalex