Foreign Exchange Return Predictability: Rational Expectations Risk Premium vs. Expectational Errors

39 Pages Posted: 2 Jan 2019

Date Written: December 30, 2018

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.

Keywords: Violations of Uncovered Interest Parity, Expectational Errors, Rational Expectations Risk Premium, Foreign Exchange Excess Returns, Serial Dependence

JEL Classification: F31, F37, G15

Suggested Citation

Moon, Seongman, Foreign Exchange Return Predictability: Rational Expectations Risk Premium vs. Expectational Errors (December 30, 2018). East Asian Economic Review Vol. 22, No. 4 (December 2018) 467-505, DOI: http://dx.doi.org/10.11644/KIEP.EAER.2018.22.4.351. Available at SSRN: https://ssrn.com/abstract=3309048 or http://dx.doi.org/10.2139/ssrn.3309048

Seongman Moon (Contact Author)

Chonbuk National University ( email )

567, Baekje-daero
Duckjingu
Jeonju-si, Jeollabuk-do 51372
Korea, Republic of (South Korea)

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