East Asian Economic Review

Korea Institute for International Economic Policy (대외경제정책연구원)
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Foreign Exchange Return Predictability: Rational Expectations Risk Premium vs. Expectational Errors

  • Received : 2018.08.02
  • Accepted : 2018.10.19
  • Published : 2018.12.30
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Abstract

We propose a simple identification scheme for the causes of the violations of uncovered interest parity. Our method uses the serial dependence patterns of excess returns as a criterion for judging performance of economic models. We show that a mean reverting component in excess returns, representing a violation of uncovered interest parity, mainly contributes to generating different serial dependence patterns of excess returns: rational expectations risk premium models tend to generate negative serial dependence of excess returns, while expectational errors models tend to generate positive serial dependence.

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References

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