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A Random Walk Around the $A: Expectations, Risk, Interest Rates and Consequences for External Imbalance

Author

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  • Jeremy Smith

    (Australian National University)

  • David W.R. Gruen

    (Reserve Bank of Australia)

Abstract

Given essentially perfect capital mobility, Australian interest rates and the expected exchange rate change should satisify international arbitrage conditions. We examine an arbitrage condition for a US investor, with a view to explaining the large short-term real interest differential between Australia and the US since late 1984. We have some evidence for a risk premium until late 1985. Since then, we explain the differential as a result of foreign exchange market inefficiency or as a consequence of the market having continually and rationally expected significant real devaluation of the $A. We provide evidence for both these explanations and draw implications for the current debate on Australia’s external imbalance.

Suggested Citation

  • Jeremy Smith & David W.R. Gruen, 1989. "A Random Walk Around the $A: Expectations, Risk, Interest Rates and Consequences for External Imbalance," RBA Research Discussion Papers rdp8906, Reserve Bank of Australia.
    • Handle: RePEc:rba:rbardp:rdp8906
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    Cited by:

    1. Alison Tarditi & Gordon Menzies, 1991. "Monthly Movements in the Australian Dollar and Real Short-term Interest Differentials: An Application of the Kalman Filter," RBA Research Discussion Papers rdp9111, Reserve Bank of Australia.
    2. Alison Tarditi, 1996. "Modelling the Australian Exchange Rate, Long Bond Yield and Inflationary Expectations," RBA Research Discussion Papers rdp9608, Reserve Bank of Australia.
    3. Anthony J. Richards, 1991. "The Cost of Equity Capital in Australia: What Can We Learn from International Equity Returns?," RBA Research Discussion Papers rdp9107, Reserve Bank of Australia.
    4. Wright, Robert S. & Gilmour, Karen & Matthews, Lynette & O'Mara, L. Paul, 1991. "Some Implications of Microeconomic Reform for the Macroeconomy and the Commodities Sector," 1991 Conference (35th), February 11-14, 1991, Armidale, Australia 145716, Australian Agricultural and Resource Economics Society.
    5. Asraul Hoque, 1995. "Co-integrating relationship between terms of trade and current account deficit: the Australian evidence," Applied Economics Letters, Taylor & Francis Journals, vol. 2(4), pages 130-133.
    6. M. K. Lewis & M. Polasek, 1990. "Whither the Balance of Payments?," Australian Economic Review, The University of Melbourne, Melbourne Institute of Applied Economic and Social Research, vol. 23(3), pages 5-16, September.
    7. Kenneth F. Wallis, 1993. "On Macroeconomic Policy and Macroeconometric Models," The Economic Record, The Economic Society of Australia, vol. 69(2), pages 113-130, June.
    8. David W. R. Gruen & Jeremy Smith, 1994. "Excess Returns in a Small Open Economy," The Economic Record, The Economic Society of Australia, vol. 70(211), pages 381-396, December.
    9. David W.R. Gruen & Gordon D. Menzies, 1991. "The Failure of Uncovered Interest Parity: Is it Near-rationality in the Foreign Exchange Market?," RBA Research Discussion Papers rdp9103, Reserve Bank of Australia.
    10. K.F. Wallis, 1992. "On Macroeconomic Policy and Macroeconomic Modeling," Economics Discussion / Working Papers 92-04, The University of Western Australia, Department of Economics.
    11. Alberto Alesina & David W. R. Gruen & Matthew T. Jones, 1991. "Fiscal Adjustment, The Real Exchange Rate and Australia's External Imbalance," Australian Economic Review, The University of Melbourne, Melbourne Institute of Applied Economic and Social Research, vol. 24(3), pages 38-51, July.
    12. David W.R. Gruen, 1991. "The Effect of Steady Inflation on Interest Rates and the Real Exchange Rate in a World with Free Capital Flows," RBA Research Discussion Papers rdp9101, Reserve Bank of Australia.
    13. Joanne Copp & Robert Brooks, 1999. "Variance ratio testing of the Australian forward foreign exchange market," Applied Economics Letters, Taylor & Francis Journals, vol. 6(7), pages 417-419.
    14. David W.R. Gruen & Marianne C. Gizycki, 1993. "Explaining Forward Discount Bias: Is it Anchoring?," RBA Research Discussion Papers rdp9307, Reserve Bank of Australia.
    15. Douglas, Justin J. & Bartley, Scott W., 1997. "Risk premia in Australian interest rates," Australian Journal of Agricultural and Resource Economics, Australian Agricultural and Resource Economics Society, vol. 41(2), pages 1-35.
    16. G. C. Lim & C. R. McKenzie, 1998. "Testing the rationality of expectations in the Australian foreign exchange market using survey data with missing observations," Applied Financial Economics, Taylor & Francis Journals, vol. 8(2), pages 181-190.

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