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International asset pricing and exchange rate risk: theoretical exposition, numerical analysis, and empirical investigation under integrated and frictional capital markets

Drexel University
Publication Date
  • Capital Assets Pricing Model
  • Foreign Exchange Rates
  • Market Segmentation
  • Public Welfare
  • Finance
  • Economics


This thesis examines the impact of exchange rate risk on asset pricing under varying market structures. To understand this effect, in the first part of the thesis the analytical derivation of an international asset-pricing model within a mean-variance framework is attempted. In the second part, to gain more insight to what the model shows economically, the price comparisons and changes in welfare under varying market structures are numerically analyzed. Finally, in the third part of the thesis the model is investigated empirically to check whether it is supported or not by real data. The main result of the theoretical part is that as long as representative agents are consuming the imported goods they would price the exchange rate risk in asset pricing. This is because exchange rate through terms of trade would affect the real purchasing power of the consumers. In numerical part, it is shown that, in a model with real exchange rate (also terms of trade in this study) shock-absorbing effect, there is no welfare increase on integration. Finally, empirical testing of the model provides partial support for the theoretical results of the first part.

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