Are Currency Returns Really Predictable?: Unforeseeable Structural Change and the Forward Rate Anomaly

26 Pages Posted: 22 Oct 2016 Last revised: 29 Mar 2017

See all articles by Michael D. Goldberg

Michael D. Goldberg

University of New Hampshire

Olesia Kozlova

American University of Paris

Date Written: March 28, 2017

Abstract

This paper provides evidence suggesting that currency returns are not predictable. We find that the Bilson-Fama regression is not only unstable, but the instability is triggered by novel historical events. The novelty of the events implies that the structural change underpinning returns cannot be characterized ex ante by a probability rule. We show that allowing for unforeseeable structural change leads to considerably more evidence of a time-varying risk premium. It also reveals temporary correlations involving the market's forecast error. These correlations, like the bias of forward rate predictions, change at times and in ways that are not predictable.

Keywords: Asset Returns, Predictability, Structural Change, Risk, Knightian Uncertainty

JEL Classification: F31

Suggested Citation

Goldberg, Michael D. and Kozlova, Olesia, Are Currency Returns Really Predictable?: Unforeseeable Structural Change and the Forward Rate Anomaly (March 28, 2017). Available at SSRN: https://ssrn.com/abstract=2857032 or http://dx.doi.org/10.2139/ssrn.2857032

Michael D. Goldberg (Contact Author)

University of New Hampshire ( email )

Durham, NH 03824
United States
603-862-3385 (Phone)
603-862-3383 (Fax)

HOME PAGE: http://pubpages.unh.edu/~michaelg/

Olesia Kozlova

American University of Paris ( email )

31 Avenue Bosquet
Paris, 75007
France

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