Does Incomplete Spanning in International Financial Markets Help to Explain Exchange Rates?

Hanno Lustig and Adrien Verdelhan ()

No 22023, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Compared to the predictions of complete market models, actual exchange rates are puzzlingly smooth and only weakly correlated with macro-economic fundamentals, suggesting that market incompleteness plays a key role in exchange rate dynamics. Incompleteness in international financial markets introduces a stochastic wedge between the growth rates of marginal utility at home and abroad, and the change in the exchange rate. We derive a preference-free upper bound on the effects of the FX wedges. Even if domestic agents can invest only in the foreign risk-free asset, incomplete spanning fails to simultaneously match the exchange rate volatility, cyclicality and the FX risk premia in the data.

JEL-codes: F31 G12 (search for similar items in EconPapers)
Date: 2016-02
New Economics Papers: this item is included in nep-ifn and nep-upt
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Citations: View citations in EconPapers (9)

Published as Hanno Lustig & Adrien Verdelhan, 2019. "Does Incomplete Spanning in International Financial Markets Help to Explain Exchange Rates?," American Economic Review, vol 109(6), pages 2208-2244.

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Related works:
Working Paper: Does Incomplete Spanning in International Financial Markets Help to Explain Exchange Rates? (2016)
Working Paper: Does Incomplete Spanning in International Financial Markets Help to Explain Exchange Rates? (2016)
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