: I will outline the baseline closed economy long-run risks model of Bansal and Yaron in the first part of the class. Then I will extend this framework to a two country economy and focus on the ingredients that are needed in order to understand some of the key international finance puzzles. For tractability, we shall assume that preferences over consumption are such that in equilibrium no trade arises in either goods or financial assets. I will spend some time on the main econometrics issues of the consumption dynamics of this class of models and detail a number of techniques that can be used to estimate them. [Slides
Bansal and Yaron, Risks for the Long-Run: A potential resolution of asset pricing puzzles, 2004, Journal of Finance
Brandt, Cochrane, and Santa Clara, International Risk Sharing is better than you think (or exchange rates are too smooth), 2005, Journal of Monetary Economics
Hansen, Heaton, and Li, Consumption Strikes back? Measuring Long Run Risk, JPE, 2008
- Colacito and Croce, Risks for the long run and the real exchage rate, 2010, working paper
: In this class, we are going to relax the assumption that resulted in the no trade equilibrium for the model examined in class 1. Specifically, consumers will each be endowed with the stochastic supply of one country specific good, and their preferences will display a bias for the consumption of the domestic good. Since the consumers in the two countries enjoy the two goods with different intensities and their endowments are imperfectly correlated, a risk sharing opportunity will arise. The risk sharing scheme is non trivial, since agents have recursive preferences. We will be interested in characterizing efficient allocations and the properties of the resulting stochastic discount factors. As for the previous class, we are going to work out a simpler one-good economy first (due to Anderson, JET, 2005), and then tackle the problem with multple consumption goods. [Slides
Anderson, The dynamics of Risk Sensitive Allocations, JET, 2005.
Colacito and Croce, International Asset Pricing with Risk Sensitive Rare Events, 2010 working paper.
Colacito and Croce, Risk Sensitive Allocations with multiple goods: existence, survivorship, and the curse of the linear approximation, 2010, working paper.
- Pavlova and Rigobon, Asset Prices and Exchange Rates, 2007, Review of Financial Studies.