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

Author

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  • Moon, Seongman

    (Chonbuk National University)

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.

Suggested Citation

  • Moon, Seongman, 2018. "Foreign Exchange Return Predictability: Rational Expectations Risk Premium vs. Expectational Errors," East Asian Economic Review, Korea Institute for International Economic Policy, vol. 22(4), pages 467-505, December.
    • Handle: RePEc:ris:eaerev:0351
    DOI: 10.11644/KIEP.EAER.2018.22.4.351
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    Keywords

    Violations of Uncovered Interest Parity; Expectational Errors; Rational Expectations Risk Premium; Foreign Exchange Excess Returns; Serial Dependence;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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