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International Capital Markets Structure, Preferences and Puzzles: A US-China World

Journal of International Financial Markets, Institutions and Money, Vol. 36, pp. 85-99

Authors:
Guglielmo Maria Caporale,
Michael Donadelli,
Alessia Varani
Research Area:
Financial Markets
Date:
May 2015
Keywords:
Macro-anomalies, Financial autarky, Complete markets, Long-run innovations, Home bias
Abstract:

The US–China data suggest that (i) the real exchange rate (RER) volatility puzzle (high RER volatility relative to consumption volatility), (ii) the Backus–Smith anomaly (negative correlation between the RER and consumption differentials), (iii) the consumption correlation puzzle (relatively low cross-country consumption correlation) became more severe in the aftermath of China's stock market liberalization. This indicates that international macro-anomalies do not show up exclusively among pairs of advanced economies. In an international endowment economy context, we show that the combination of recursive preferences and long-run risk allows for the simultaneous resolution of these anomalies. In contrast to standard macro models, this holds even in the presence of full financial integration, segmented goods markets and non-negligible changes in several parameter values.

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