International portfolio diversification, asset-return determination and foreign exchange risk premium under uncertainty

The thesis starts with the set-up of the theoretical model, which is the extended version of the consumption-Second, we extend our model further to two-country general equilibrium model, where stochastic motions of the asset return are specified as the functions of the expected changes and conditional variances of the exogenous variables the rates of growth of money supply and fiscal deficit and capital productivities in both countries. Our econometric results suggest that conditional variances of exogenous variables, especially those of the rates of growth of money supply in Japan and the U.S. and the rate of growth of fiscal deficit in the U.S. are significant in explaining the motions of long-term asset returns and yen-dollar spot exchange rate.Third, we apply the model to the motion of foreign exchange risk premium. The empirical results from time-variant coefficient model suggests that the significant downward trends in coefficient values are observed in the latter half of the 1980s. We conclude that these observations can partly be attributed to the decline in the degree of relative risk aversion of the investors on average in the process of the integration of financial markets across the countries. Also, we can obtain the implication such that the magnitudes of the effects of policy uncertainty on long-term asset returns and foreign exchange rate have substantially been lessened in the 1980s, partly due to the decrease in investor's relative risk aversion and partly due to the decrease in conditional variances of policy variables.