Equilibrium asset prices and exchange rates

Abstract In a two-country two-good world, we construct an intertemporal international general equilibrium for two logarithmic representative agents. Financial markets are fully integrated and independently incomplete. The equilibrium expected rate of change of the exchange rate increases with the differential of interest rates and the volatility of the domestic equity markets and decreases with the covariance between domestic and foreign equity markets. The equilibrium volatility of the exchange rate is the sum of the volatilities due to idiosyncratic factors in the financial markets and a term that represents the difference of weights in the common international factor.

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