The Global Price of Risk in Exchange Rates and Equities

Abstract

This paper studies the joint determination of exchange rates and international equity returns. I develop a general equilibrium model in which a risk-averse financial intermediary facilitates cross-border capital flows and prices both asset classes. Its mean-variance portfolio choice yields a stochastic discount factor that links currency and equity premia to a global price of risk. Recovering the model-free projection of this stochastic discount factor from international asset returns, I show that its pricing power strengthens during intermediary distress and that the compensated risk loads on productivity growth over long horizons. The model rationalizes these patterns through two complementary mechanisms. Shocks to intermediary risk aversion reprice risky assets globally, while long-run growth governs exchange rates and relative equity valuations through persistent differentials in expected income and interest rates. Quantitatively, the calibrated model reproduces key cross-asset comovements and addresses the price-quantity disconnect puzzles of international finance within a unified theoretical and empirical framework.