The Journal of Finance

The Journal of Finance publishes leading research across all the major fields of finance. It is one of the most widely cited journals in academic finance, and in all of economics. Each of the six issues per year reaches over 8,000 academics, finance professionals, libraries, and government and financial institutions around the world. The journal is the official publication of The American Finance Association, the premier academic organization devoted to the study and promotion of knowledge about financial economics.

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Asset‐pricing Puzzles and Incomplete Markets

Published: 12/01/1993   |   DOI: 10.1111/j.1540-6261.1993.tb05129.x

CHRIS I. TELMER

The representative agent theory of asset pricing is modified to incorporate heterogeneous agents and incomplete markets. The model features two types of agents who differ up to a nontradable, idiosyncratic component in their endowment processes. Numerical solutions indicate that individuals are able to diversify a substantial portion of their idiosyncratic income risk through riskless borrowing and lending alone. Restrictions on the variability of intertemporal marginal rates of substitution (Hansen and Jagannathan (1991)) are used to argue that incomplete markets, as modeled here, cannot account for the properties of asset returns that are anomalous from the perspective of representative agent theory.


Affine Term Structure Models and the Forward Premium Anomaly

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00325

David K. Backus, Silverio Foresi, Chris I. Telmer

One of the most puzzling features of currency prices is the forward premium anomaly: the tendency for high interest rate currencies to appreciate. We characterize the anomaly in the context of affine models of the term structure of interest rates. In affine models, the anomaly requires either that state variables have asymmetric effects on state prices in different currencies or that nominal interest rates take on negative values with positive probability. We find the quantitative properties of either alternative to have important shortcomings.


Accounting for Forward Rates in Markets for Foreign Currency

Published: 12/01/1993   |   DOI: 10.1111/j.1540-6261.1993.tb05132.x

DAVID K. BACKUS, ALLAN W. GREGORY, CHRIS I. TELMER

Forward and spot exchange rates between major currencies imply large standard deviations of both predictable returns from currency speculation and of the equilibrium price measure (the intertemporal marginal rate of substitution). Representative agent theory with time‐additive preferences cannot account for either of these properties. We show that the theory does considerably better along these dimensions when the representative agent's preferences exhibit habit persistence, but that the theory fails to reproduce some of the other properties of the data—in particular, the strong autocorrelation of forward premiums.