The Expected Marginal Rate of Substitution in the United States and Canada

This paper applies a new methodology to estimate the expected intertemporal marginal rate of substitution or “EMRS”, using only data on asset prices and returns. A novel feature of the technique is that it relies upon exploiting idiosyncratic risk, since theory dictates that idiosyncratic shocks earn the EMRS. I apply the methodology to two different data sets: monthly data from 1994 through 2003, and daily data for 2003. Both data sets include large stocks traded on the New York and Toronto Stock Exchanges. For both monthly and daily frequencies, I find plausible estimates of EMRS with considerable precision and time-series volatility. I then use these estimates to test for asset integration, both within and between stock markets. I find that both markets seem to be internally integrated in the sense that different assets traded on a given market share the same EMRS. More interestingly, the technique is powerful enough to reject integration between the two stock markets, and between stock and bond markets. JEL Classification Numbers: G14