Export pricing and the cross-country correlation of stock prices

This study analyses cross-country correlations of stock prices (values of firms) using the basic New Open Economy Macroeconomics model. We show that cross-country correlations of stock prices greatly depend on the currency of export pricing in the case of monetary shocks but not notably for temporary technology shocks. In the case of a money supply shock, the producer (local) currency pricing version of the model generates a negative (positive) cross-country correlation of stock prices.

Introduction: In open economy macroeconomics, economists have often analysed cross-country correlations of output and consumption. A common result is that the cross-country correlation of consumption is higher than that of output.This is inconsistent with empirical evidence showing that output is more highly correlated than consumption across countries (Backus et al, 1992).Cross-country correlation of stock prices has received less attention despite the fact that many modern macro models with solid microfoundations in firms’ optimizing problems could be used to generate predictions of stock prices. If a macro model provides a good description of reality, it should be able to explain — partly — the movements in stock prices. The main purpose of this paper is to analyse the asset pricing implications of the basic New Open Economy Macroeconomics (NOEM) model. To address this topic I present a standard NOEM model that enables one to study the implications of the currency of export pricing (local versus producer currency pricing) for the cross-country correlations of stock prices. A stock price refers to the net present value of all future profits (dividends) of the firm.

Author: Juha Tervala

Source: Research Discussion Papers, Bank of Finland

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