March 23, 2018
2:00 PM
CORE (room b-135)
Model-free International Stochastic Discount Factors
Andrea Vedolin, London School of Economics
We provide a theoretical characterization of international stochastic discount factors (SDFs) in incomplete markets under different degrees of market segmentation. Using 40 years of data on a cross-section of countries, we estimate model-free SDFs and factorize them into permanent and transitory components. We find that large permanent SDF components help to reconcile
the low exchange rate volatility, the exchange rate cyclicality, and the forward premium anomaly. However, under integrated markets, this entails highly volatile and almost perfectly comoving
international SDFs. In contrast, segmented markets can generate less volatile and more dissimilar SDFs. In quest of relating the SDFs to economic fundamentals, we document strong links between proxies of financial intermediaries’ risk-bearing capacity and model-free international SDFs.