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Mundell-Fleming with Stock Market and Endogenous Risk Premium

  • Soumyen Sikdar
Chapter

Abstract

In the textbook Mundell-Fleming analysis of an open economy in the short run interest bearing bonds are the only assets and expectation about exchange rate movements is usually taken to be static. This is not a good description of the Indian economy where capital inflow in recent years has predominantly taken the form of portfolio investment in stocks and it is driven very strongly by expectations of capital gains. The present exercise is a reformulation that departs from the standard model by replacing (a) the home bond by home stock and (b) static expectations by regressive (stabilizing) expectations. Country risk is captured in the standard model through the introduction of risk premium which is taken as an exogenous parameter. We have made the risk premium endogenous by making it dependent on the country’s current account deficit and the government’s budget deficit. These modifications produce some new results that do not hold in the textbook version.

Keywords

Exchange Rate Stock Market Stock Return Risk Premium Money Supply 
These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

References

  1. Basu, R., Nag, R. (2011). Stock market, capital flow and output, some analytical and policy perspectives, Macroeconomics and Finance in Emerging Market Economies, March, 85–99.Google Scholar
  2. Blanchard, O. (1981). Output, the stock market, and interest rates, American Economic Review, 71(1), 132–143.Google Scholar
  3. Fischer, S., Merton, R. (1984). Macroeconomics and finance: the role of the stock market. NBER Working Paper 1291, March.Google Scholar

Copyright information

© Springer India 2014

Authors and Affiliations

  1. 1.Indian Institute of Management CalcuttaKolkataIndia

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