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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.