Implications of incomplete markets for international economies

Bakshi, G., Cerrato, M. and Crosby, J. (2018) Implications of incomplete markets for international economies. Review of Financial Studies, 31(10), pp. 4017-4062. (doi: 10.1093/rfs/hhx120)

Abstract

We develop a restriction that precludes implausibly high reward-for-risk in incomplete inter- national 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 corre- lations of macroeconomic quantities, namely, consumption, wealth, dividend growths, and asset returns, our empirical investigation refutes the specification of complete markets.

• Item Type: Articles
• Status: Published
• Refereed: Yes
• Glasgow Author(s) Enlighten ID: Cerrato, Professor Mario
• Authors: Bakshi, G., Cerrato, M., and Crosby, J.
• College/School: College of Social Sciences > Adam Smith Business School > Economics
• Journal Name: Review of Financial Studies
• Publisher: Oxford University Press
• ISSN: 0893-9454
• ISSN (Online): 1465-7368
• Published Online: 23 October 2017
• Copyright Holders: Copyright © 2017 The Authors
• First Published: First published in Review of Financial Studies 31(10): 4017-4062
• Publisher Policy: Reproduced in accordance with the publisher copyright policy