Title: On the relative performance of consumption models in foreign and domestic markets

Authors: Paulo Matos; Carlor E. Da Costa

Addresses: Pós-Graduação em Economia da Universidade federal do Ceará, Avenida da Universidade, 2700, Fortaleza, CE 60020181, Brazil ' Escola de Pós-Graduação em Economia da Fundação Getulio Vargas, Praia de Botafogo, 190 11o andar, Rio de Janeiro, RJ 22250-900, Brazil

Abstract: We revisit the literature that explores the relationship between domestic and foreign markets asset pricing puzzles, by evaluating the relative performance of different consumption-based models. We estimate and test the overidentifying restrictions of Euler equations associated with the consumption capital asset pricing model, in its canonical and main reference level versions. Our main findings are: 1) similar, however unreasonable, values for the parameters are obtained for most of the models in both equity and foreign exchange markets; 2) rejections or otherwise of overidentifying restrictions occurs for the two markets, suggesting that success and failure stories for each model takes place in the other market. We also compare the consumption-based pricing kernel with a preference-free pricing kernel built in da Costa et al. (2015) and perform in-sample predictions exercises. Our work provides empirical grounds to believe that progresses on preference-based solutions to puzzles in domestic financial markets will shed light on puzzles in foreign exchange market as, for example, recent work by Verdelhan (2010).

Keywords: equity premium; foreign currencies; currency risk premium; asset pricing models; habit formation; external time-varying reference consumption level; consumption models; foreign markets; domestic markets; modelling; consumption capital asset pricing; equity markets.

DOI: 10.1504/IJFMD.2016.081697

International Journal of Financial Markets and Derivatives, 2016 Vol.5 No.2/3/4, pp.154 - 188

Received: 19 May 2016
Accepted: 30 Jun 2016
Published online: 20 Jan 2017 *

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