Yields, Risk Premium, and Terms of Trade
Abstract
The theoretical framework, Purchasing Power Parity (PPP), and Interest Rate Parity (IRP) have very clear implications. Under such idealized conditions, we expect that in an unfettered free market, real rates of returns will be equalized. Add tax rates, regulations, and/or transportation costs, and we can easily explain how economic disturbances give rise to deviation from PPP and IRP, which are correlated to the stock market’s relative performance. More importantly, some of the arguments presented here suggest that fiscal policy differences and other economic shocks will give rise to the changes in terms of trade, as well as impacting the risk premium as we have defined it. To the extent ...
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