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132 CHAPTER 4. THE LUCAS MODEL1.02A. Depreciation and Forward Premium1.011.000.990.980.9773 75 77 79 81 83 85 87 89 91 93 950.03B. Ex Post Profit and Risk Premium0.020.010.00-0.01-0.02-0.03-0.0473 75 77 79 81 83 85 87 89 91 93 95Figure 4.1: From the Lucas Model. A: Implied gross one-period aheadchange in nominal exchange rate S t+1 /S t and current forward premiumF t /S t (in boxes). B. Implied ex post forward payoff (S t+1 − F t )/S t(jagged line) and risk premium E t (S t+1 − F t )/S t (smooth line).
4.5. CALIBRATING THE LUCAS MODEL 133Lucas Model Summary1. It is a ßexible-price, complete markets, dynamic general equilibriummodel with optimizing agents. It is logically consistent andprovides the micro-foundations for international asset pricing.2. The Lucas model provides a framework for pricing assets, includingthe exchange rate, in an international setting. The exchangerate depends on the same set of fundamental variables as predictedby the monetary model. The empirical predictions of themodel will be developed more fully in chapter 6.3. Thereisnotradingvolumeforanyoftheassets. Thepricesderived in the model are shadow values under which the existingstock of assets are willingly held by the agents.4. Output is taken to be exogenous so the model not well equippedto explain quantities such as the current account.5. The Lucas model is designed to help us understand the determinationof the prices of assets–exchange rates, bonds, andstocks–that are consistent with equilibrium choices of consumption.Because it is an endowment model, the dynamics of consumption(or alternatively output) are taken exogeneously. Thisis actually a virtue of the model since a model with production,while perhaps more ‘realistic,’ does not change the underlyingasset pricing formulae which are based on the Euler equationsfor the consumer’s problem but complicates the job by forcingus to write down a model where equilibrium decisions of theÞrm generate not only realistic asset price movements but alsorealistic output dynamics. It is therefore not necessary or evendesirable to introduce production in order to understand equilibriumasset pricing issues.
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To Shirley, Laurie, and Leslii
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CONTENTSvii11 Balance of Payments C
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2 CHAPTER 1. SOME INSTITUTIONAL BAC
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10 CHAPTER 1. SOME INSTITUTIONAL BA
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24 CHAPTER 2. SOME USEFUL TIME-SERI
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80 CHAPTER 3. THE MONETARY MODEL3.1
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Page 170 and 171: 162CHAPTER 6. FOREIGN EXCHANGE MARK
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182CHAPTER 6. FOREIGN EXCHANGE MARK
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208 CHAPTER 7. THE REAL EXCHANGE RA
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230 CHAPTER 8. THE MUNDELL-FLEMING
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264CHAPTER 9. THE NEW INTERNATIONAL
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308 CHAPTER 10. TARGET-ZONE MODELSa
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310 CHAPTER 10. TARGET-ZONE MODELSt
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312 CHAPTER 10. TARGET-ZONE MODELSC
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314 CHAPTER 10. TARGET-ZONE MODELSl
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316 CHAPTER 10. TARGET-ZONE MODELST
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318 CHAPTER 10. TARGET-ZONE MODELSa
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320 CHAPTER 10. TARGET-ZONE MODELSM
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322 CHAPTER 10. TARGET-ZONE MODELSt
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324 CHAPTER 10. TARGET-ZONE MODELS
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326 CHAPTER 10. TARGET-ZONE MODELS
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328 CHAPTER 11. BALANCE OF PAYMENTS
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358 AUTHOR INDEXFama, E.F., 161, 16
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Subject IndexAAbsorption, 16, 230AI
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362 SUBJECT INDEXEfficient capital
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364 SUBJECT INDEXMethod of undeterm
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366 SUBJECT INDEXRisk neutrality, 9
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368 SUBJECT INDEXImpulse response a
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