International capital markets and redundant securities

In this paper we propose a general equilibrium model of a two-country, two-good complete dynamic financial market. We fully characterize the equilibrium, and show that under time-additively separable preferences there exist redundant securities in international capital markets. For example, using the foreign bond and domestic securities, investors are able to replicate foreign equity. However, unlike Zapatero (1995. Equilibrium Asset prices and exchange rates. Journal of Economic Dynamics and Control 19, 787-811) and Pavlova and Rigobon (2003. Asset prices and exchange rate. NBER Working Paper # 9834), the perfect correlation between equity markets obtained under the restrictive assumption of logarithmic preferences does not hold under more general specifications of utility, even though the pricing kernels in the two countries are perfectly linked through the exchange rate.