The Implications of Mean-Variance Optimization for Four Questions in International Macroeconomics

Jeffrey A. Frankel

NBER Working Paper No. 1617 (Also Reprint No. r0737)
Issued in May 1985
NBER Program(s):International Trade and Investment, International Finance and Macroeconomics

The hypothesis that investors optimize with respect to the mean and variance of their end-of-period wealth has powerful implications for some standard questions of interest to international macroeconomists. The implications transcend the particular econometric technique used to estimate the return variance-covarjance matrix. (1) For conventional estimates of risk-aversion, substitutability between domestic and foreign securities is close to perfect in the sense that risk premiums are small in magnitude (a few basis points), and thus cannot explain much bias in forward rates. (2) Nevertheless, as long as risk-aversion is not zero, foreign exchange intervention still affects the level of the exchange rate. If interest rates are held constant, the effect is proportionate to the contemporaneous change in asset supplies, and is more-than-proportionate if the expectations of future asset supplies also change. (3) Current account deficits have effects that are comparable to, though smaller in magnitude than,the effects of equal-sized changes in asset supplies through intervention or government borrowing. (4) The perceived tendency for dollar depreciation to be associated with appreciation of the mark against the franc is not consistent with the implication of mean-variance optimization that the franc should bea closer substitute for the dollar than is the mark.

download in pdf format
   (345 K)

download in djvu format
   (264 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w1617

Published: Frankel, Jeffrey A. "The Implications of Mean-Variance Optimization for Four Questions in International Macroeconomics," Journal of International Money and Finance, Vol. 5, Supplement, (March 1986), pp. S53-S75. citation courtesy of

Users who downloaded this paper also downloaded* these:
Koopman, Wang, and Wei w14109 How Much of Chinese Exports is Really Made In China? Assessing Domestic Value-Added When Processing Trade is Pervasive
Dornbusch w0493 Exchange Rate Risk and the Macroeconomics of Exchange Rate Determination
Flood and Taylor Exchange Rate Economics: What's Wrong with the Conventional Macro Approach?
Fuchs w1605 Paying the Piper, Calling the Tune: Implications of Changes in Reimbursement
Abraham and Farber w2368 Returns to Seniority in Union and Nonunion Jobs: A New Look at the Evidence
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us