How to determine exchange rates under risk neutrality: A note

Stefano Bosi (), Patrice Fontaine and Cuong Le Van ()
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Stefano Bosi: EPEE - Centre d'Etudes des Politiques Economiques - UEVE - Université d'Évry-Val-d'Essonne
Patrice Fontaine: EUROFIDAI - Institut Européen de données financières - ESSEC Business School - CNRS - Centre National de la Recherche Scientifique
Cuong Le Van: IPAG Business School, CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres - EHESS - École des hautes études en sciences sociales - ENPC - École nationale des ponts et chaussées - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement, TIMAS - Institute of Mathematics and Applied Science

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Abstract: The goal of this paper is to determine the exchange rates consistent with an equilibrium in the international assets and goods markets. We present a wealth model of a two-country economy where financial assets and goods are traded. We consider the case where the agents are risk neutral, a very common assumption in finance in order to have explicit solutions for prices, and, in particular, in international finance for exchange rates using the non-null Pareto optima. We show that the Pareto optima in the international assets and goods markets are found to coincide with the net trade allocations. More notably, under a no-arbitrage condition in the assets markets, we can define an exchange rates system for which PPP holds. We provide conditions to have a non-null Pareto optimum to compute the exchange rates. We give an example with a non-null Pareto optimum associated with the determination of the exchange rate. © 2017 Elsevier B.V.

Keywords: Exchange rates; International asset pricing; No-arbitrage conditions; Returns on securities (search for similar items in EconPapers)
Date: 2017-08
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Citations: View citations in EconPapers (5)

Published in Economics Letters, 2017, 157, pp.92--96. ⟨10.1016/j.econlet.2017.05.015⟩

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Journal Article: How to determine exchange rates under risk neutrality: A note (2017)
Working Paper: How to determine exchange rates under risk neutrality: A note (2017)
Working Paper: How to determine exchange rates under risk neutrality: A note (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-02877955

DOI: 10.1016/j.econlet.2017.05.015

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