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Trends in Expected Returns in Currency and Bond Markets

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  • Martin D. Evans
  • Karen K. Lewis

Abstract

Under conventional notions about rational expectations and market efficiency, expected returns differ from the actual expost returns by a forecast error that is uncorrelated with current information. In this paper, we describe how small departures from conventional notions of rational expectations and market efficiency can produce trends in excess returns. These trends are in addition to the trends typically found in the level of asset prices themselves. We report strong evidence for the presence of additional trends in excess foreign exchange and bond returns. We also estimate the additional trend component in excess returns on foreign exchange and find that it varied between -.8% and 1% for one month returns and between -6% and 8% for three month returns.
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Suggested Citation

  • Martin D. Evans & Karen K. Lewis, 1992. "Trends in Expected Returns in Currency and Bond Markets," Working Papers 92-20, New York University, Leonard N. Stern School of Business, Department of Economics.
    • Handle: RePEc:ste:nystbu:92-20
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    Cited by:

    1. Nelson, Charles R & Piger, Jeremy & Zivot, Eric, 2001. "Markov Regime Switching and Unit-Root Tests," Journal of Business & Economic Statistics, American Statistical Association, vol. 19(4), pages 404-415, October.
    2. Kim, Chang-Jin & Piger, Jeremy, 2002. "Common stochastic trends, common cycles, and asymmetry in economic fluctuations," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1189-1211, September.
    3. Chang‐Jin Kim & Jeremy M. Piger & Richard Startz, 2007. "The Dynamic Relationship between Permanent and Transitory Components of U.S. Business Cycles," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(1), pages 187-204, February.
    4. Chang-Jin Kim & Jeremy M. Piger & Richard Startz, 2001. "Permanent and transitory components of business cycles: their relative importance and dynamic relationship," International Finance Discussion Papers 703, Board of Governors of the Federal Reserve System (U.S.).
    5. Charles Nelson & Jeremy Piger & Eric Zivot, 1999. "Unit Root Tests in the Presence of Markov Regime-Switching," Discussion Papers in Economics at the University of Washington 0040, Department of Economics at the University of Washington.
    6. Christodoulakis, Nicos M. & Kalyvitis, Sarantis C., 1997. "Efficiency testing revisited: a foreign exchange market with Bayesian learning," Journal of International Money and Finance, Elsevier, vol. 16(3), pages 367-385, June.
    7. Jun Nagayasu, 2011. "The Common Component in Forward Premiums: Evidence from the Asia–Pacific Region," Review of International Economics, Wiley Blackwell, vol. 19(4), pages 750-762, September.
    8. Crowder, William J., 1995. "Covered interest parity and international capital market efficiency," International Review of Economics & Finance, Elsevier, vol. 4(2), pages 115-132.

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