Asset Price Movements Research Articles

The impact of supply shocks on exchange rates and interest rates: Does the Marshall-Lerner condition matter?

We examine the dynamic response of the exchange rate, the terms of trade and interest rates to supply shocks in a rational expectation (stochastic) environment. We establish the proposition that the Marshall-Lerner elasticity condition is sufficient to guarantee that an exogenous increase in real economic growth will appreciate the exchange rate, regardless of assumptions concerning market clearing and price flexibility. In specialized cases the traditional Marshall-Lerner condition is sufficient to establish propositions concerning exchange rate overshooting, the direction and magnitude of financial asset price movements and relative volatilities under flexible versus anticipatory pricing regimes.

Asset Prices in an Exchange Economy

THIS PAPER IS A THEORETICAL examination of the stochastic behavior of equilibrium asset prices in a one-good, pure exchange economy with identical consumers. The single good in this economy is (costlessly) produced in a number of different productive units; an asset is a claim to all or part of the output of one of these units. Productivity in each unit fluctuates stochastically through time, so that equilibrium asset prices will fluctuate as well. Our objective will be to understand the relationship between these exogenously determined productivity changes and market determined movements in asset prices. Most of our attention will be focused on the derivation and application of a functional equation in the vector of equilibrium asset prices, which is solved for price as a function of the physical state of the economy. This equation is a generalization of the Martingale property of stochastic price sequences, which serves in practice as the defining characteristic of market efficiency, as that term is used by Fama [7] and others. The model thus serves as a simple context for examining the conditions under which a price series' failure to possess the Martingale property can be viewed as evidence of non-competitive or irrational behavior. The analysis is conducted under the assumption that, in Fama's terms, prices fully reflect all available an hypothesis which Muth [13] had earlier termed rationality of expectations. As Muth made clear, this hypothesis (like utility maximization) is not behavioral: it does not describe the way agents think about their environment, how they learn, process information, and so forth. It is rather a property likely to be (approximately) possessed by the outcome of this unspecified process of learning and adapting. One would feel more comfortable, then, with rational expectations equilibria if these equilibria were accompanied by some form of stability theory which illuminated the forces which move an economy toward equilibrium. The present paper also offers a convenient context for discussing this issue. The conclusions of this paper with respect to the Martingale property precisely replicate those reached earlier by LeRoy (in [10] and [11]), and not surprisingly, since the economic reasoning in [10] and the present paper is the same. The