Stock Market Returns and Economic Fundamentals in an Emerging Market: The Case of Korea

This paper investigates the feedback relationship between stock market returnsand economic fundamentals in an emerging market. Starting from an intertemporalconsumption-based CAPM (CCAPM), we obtain a restricted VAR model for stockreturns and macroeconomic variables. We then apply this model to Korea and findstatistically significant departures from the restrictions implied by CCAPM.Consequently, an unrestricted VAR model is used to analyze the variations of expectedand unexpected returns in the Korean stock market. It is shown that the expectedmarket returns vary with a set of macroeconomic variables, and that thepredictable component is substantial. Reflecting richer dynamics in the data,relative to the usual single equation modeling in the literature, the estimatedVAR model shows considerable predictive ability for both real economic activityand real returns. Using the model for a variance decomposition of unexpectedreturns, we find that, although we cannot directly observe the market's revisionof expected future dividend growth, we can estimate a large part of therevision with the news in the expected industry output growth from our VAR model.Finally, we also find that economic fundamentals can explain only a smallportion of the variation in unexpected returns in the Korean stock market.     

International Asset Pricing with Recursive Preferences

Focusing on data from the United States and the United Kingdom, we document that both the anomaly identified by Backus and Smith, which concerns the low correlation between consumption differentials and exchange rates, and the forward premium anomaly, which concerns the tendency of high interest rate currencies to appreciate, have become more severe over time. Taking into account different capital mobility regimes, we show that these anomalies turn into general equilibrium regularities in a two‐country and two‐good economy with Epstein and Zin preferences, frictionless markets, and correlated long‐run growth prospects.     

Centralization vs. Decentralization: A Principal-Agent Analysis

The decision to allocate policy jurisdictions to different levels of government is related to a number of trade‐offs between the advantages and disadvantages of centralized versus decentralized provision of public services. A trade‐off central to many discussions is that between the internalization of externalities under centralization versus an “accountability” advantage of decentralization. In this paper we formalize this trade‐off in the context of a class of principal–agent models known as common agency.