Forward and spot exchange rates
TL;DR: In this paper, the authors find that most of the variation in forward rates is variation in premium, and the premium and expected future spot rate components of forward rates are negatively correlated, and they conclude that the forward market is not efficient or rational.
About: This article is published in Journal of Monetary Economics.The article was published on 1984-11-01. It has received 2217 citations till now. The article focuses on the topics: Forward exchange rate & Forward premium anomaly.
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TL;DR: A survey and review of the major econometric work on long memory processes, fractional integration, and their applications in economics and finance and some of the definitions of long memory are reviewed.
1,950 citations
TL;DR: Discount-rate variation is the central organizing question of current asset-pricing research as discussed by the authors, and a survey of discount-rate theories and applications can be found in the survey.
Abstract: Discount-rate variation is the central organizing question of current asset-pricing research. I survey facts, theories, and applications. Previously, we thought returns were unpredictable, with variation in price-dividend ratios due to variation in expected cashflows. Now it seems all price-dividend variation corresponds to discount-rate variation. We also thought that the cross-section of expected returns came from the CAPM. Now we have a zoo of new factors. I categorize discount-rate theories based on central ingredients and data sources. Incorporating discount-rate variation affects finance applications, including portfolio theory, accounting, cost of capital, capital structure, compensation, and macroeconomics.
1,624 citations
Additional excerpts
...9 Hansen and Hodrick (1980), Fama (1984)....
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Posted Content•
TL;DR: In this article, 1-year forward rates on 1- to 5-year U.S. Treasury bonds are used to forecast changes in the 1-to-5-year interest rate 2-to l-years ahead, and forecast power increases with the forecast horizon.
Abstract: Current 1 -year forward rates on 1 - to 5-year U.S. Treasury bonds are information about the current term structure of 1-year expected returns on the bonds, and forward rates track variation through time in 1-year expected returns. More interesting, 1 -year forward rates forecast changes in the 1 -year interest rate 2- to l-years ahead, and forecast power increases with the forecast horizon. We attribute this forecast power to a mean-reverting tendency in the 1-year interest rate
1,595 citations
Cites background or methods from "Forward and spot exchange rates"
...Equation (5) is the basis for much of the empirical 8 Consider, e.g., the findings in Fama (1984) and Fama and Bliss (1987). analysis to follow....
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...Table 4 replicates the regression analysis in Fama and Bliss (1987) and Jorion and 13 See, e.g., Fama (1984a), Bekaert and Hodrick (2001)....
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...For the exchange rate and term structure hypotheses, there is ample evidence that the short and long runs behave quite differently.8 As pointed out by Fama (1984a) and in our findings to follow on exchange rates, it is this divergence that is most interesting....
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...In fact, consistent with the negative sign in the 15 See, e.g., Fama (1984b) and Bekaert (1996) for risk premia explanations....
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Book•
01 Jan 2002TL;DR: In the last few decades exchange rate economics has seen a number of developments, with substantial contributions to both the theory and empirics of exchange rate determination as mentioned in this paper. But, while our understanding of exchange rates has significantly improved, a few challenges and open questions remain in the exchange rate debate, enhanced by events including the launch of the Euro and the large number of recent currency crises.
Abstract: Description Contents Resources Courses About the Authors
In the last few decades exchange rate economics has seen a number of developments, with substantial contributions to both the theory and empirics of exchange rate determination. Important developments in econometrics and the increasingly large availability of high-quality data have also been responsible for stimulating the large amount of empirical work on exchange rates in this period. Nonetheless, while our understanding of exchange rates has significantly improved, a number of challenges and open questions remain in the exchange rate debate, enhanced by events including the launch of the Euro and the large number of recent currency crises. This volume provides a selective coverage of the literature on exchange rates, focusing on developments from within the last fifteen years. Clear explanations of theories are offered, alongside an appraisal of the literature and suggestions for further research and analysis.
1,222 citations
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TL;DR: A survey of advances in this area since the publication of Hodrick's (1987) survey is presented in this paper, with a focus on the relationship between uncovered interest parity and real interest parity.
Abstract: Forward exchange rate unbiasedness is rejected in tests from the current floating exchange rate era. This paper surveys advances in this area since the publication of Hodrick's (1987) survey. It documents that the change in the future exchange rate is generally negatively related to the forward discount. Properties of the expected forward forecast error are reviewed. Issues such as the relation of uncovered interest parity to real interest parity, and the implications of uncovered interest parity for cointegration of various quantities are discussed. The modeling and testing for risk premiums is surveyed. Included in this area are tests of the consumption CAPM, tests of the latent variable model, and portfolio-balance models of risk premiums. General equilibrium models of the risk premium are examined and their empirical implications explored. The survey does not cover the important areas of learning and peso problems, tests of rational expectations based on survey data, or the models of irrational expectations and speculative bubbles.
1,137 citations
References
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TL;DR: In this paper, the authors present a body of positive microeconomic theory dealing with conditions of risk, which can be used to predict the behavior of capital marcets under certain conditions.
Abstract: One of the problems which has plagued thouse attempting to predict the behavior of capital marcets is the absence of a body of positive of microeconomic theory dealing with conditions of risk/ Althuogh many usefull insights can be obtaine from the traditional model of investment under conditions of certainty, the pervasive influense of risk in finansial transactions has forced those working in this area to adobt models of price behavior which are little more than assertions. A typical classroom explanation of the determinationof capital asset prices, for example, usually begins with a carefull and relatively rigorous description of the process through which individuals preferences and phisical relationship to determine an equilibrium pure interest rate. This is generally followed by the assertion that somehow a market risk-premium is also determined, with the prices of asset adjusting accordingly to account for differences of their risk.
17,922 citations
Additional excerpts
...Examples are the international version of the Sharpe (1964) and Lintner (1965) model discussed by Fama and Farber (1979) or the version of the l.,ucas (1978) model discussed by Hodrick and Srivastava (1984). l'he lock between the premium in the forward exchange rate a~d the interest rates on the…...
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TL;DR: In this article, the problem of selecting optimal security portfolios by risk-averse investors who have the alternative of investing in risk-free securities with a positive return or borrowing at the same rate of interest and who can sell short if they wish is discussed.
Abstract: Publisher Summary This chapter discusses the problem of selecting optimal security portfolios by risk-averse investors who have the alternative of investing in risk-free securities with a positive return or borrowing at the same rate of interest and who can sell short if they wish. It presents alternative and more transparent proofs under these more general market conditions for Tobin's important separation theorem that “ … the proportionate composition of the non-cash assets is independent of their aggregate share of the investment balance … and for risk avertere in purely competitive markets when utility functions are quadratic or rates of return are multivariate normal. The chapter focuses on the set of risk assets held in risk averters' portfolios. It discusses various significant equilibrium properties within the risk asset portfolio. The chapter considers a few implications of the results for the normative aspects of the capital budgeting decisions of a company whose stock is traded in the market. It explores the complications introduced by institutional limits on amounts that either individuals or corporations may borrow at given rates, by rising costs of borrowed funds, and certain other real world complications.
9,970 citations
Additional excerpts
...Examples are the international version of the Sharpe (1964) and Lintner (1965) model discussed by Fama and Farber (1979) or the version of the l.,ucas (1978) model discussed by Hodrick and Srivastava (1984). l'he lock between the premium in the forward exchange rate a~d the interest rates on the…...
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TL;DR: In this paper, a method of estimating the parameters of a set of regression equations is reported which involves application of Aitken's generalized least-squares to the whole system of equations.
Abstract: In this paper a method of estimating the parameters of a set of regression equations is reported which involves application of Aitken's generalized least-squares [1] to the whole system of equations. Under conditions generally encountered in practice, it is found that the regression coefficient estimators so obtained are at least asymptotically more efficient than those obtained by an equation-by-equation application of least squares. This gain in efficiency can be quite large if “independent” variables in different equations are not highly correlated and if disturbance terms in different equations are highly correlated. Further, tests of the hypothesis that all regression equation coefficient vectors are equal, based on “micro” and “macro” data, are described. If this hypothesis is accepted, there will be no aggregation bias. Finally, the estimation procedure and the “micro-test” for aggregation bias are applied in the analysis of annual investment data, 1935–1954, for two firms.
7,637 citations
TL;DR: In this article, the authors examine the stochastic behavior of equilibrium asset prices in a one-good, pure exchange economy with identical consumers, and derive a functional equation for price as a function of the physical state of the economy.
Abstract: THIS PAPER IS A THEORETICAL examination of the stochastic behavior of equilibrium asset prices in a one-good, pure exchange economy with identical consumers. The single good in this economy is (costlessly) produced in a number of different productive units; an asset is a claim to all or part of the output of one of these units. Productivity in each unit fluctuates stochastically through time, so that equilibrium asset prices will fluctuate as well. Our objective will be to understand the relationship between these exogenously determined productivity changes and market determined movements in asset prices. Most of our attention will be focused on the derivation and application of a functional equation in the vector of equilibrium asset prices, which is solved for price as a function of the physical state of the economy. This equation is a generalization of the Martingale property of stochastic price sequences, which serves in practice as the defining characteristic of market "efficiency," as that term is used by Fama [7] and others. The model thus serves as a simple context for examining the conditions under which a price series' failure to possess the Martingale property can be viewed as evidence of non-competitive or "irrational" behavior. The analysis is conducted under the assumption that, in Fama's terms, prices "fully reflect all available information," an hypothesis which Muth [13] had earlier termed "rationality of expectations." As Muth made clear, this hypothesis (like utility maximization) is not "behavioral": it does not describe the way agents think about their environment, how they learn, process information, and so forth. It is rather a property likely to be (approximately) possessed by the outcome of this unspecified process of learning and adapting. One would feel more comfortable, then, with rational expectations equilibria if these equilibria were accompanied by some form of "stability theory" which illuminated the forces which move an economy toward equilibrium. The present paper also offers a convenient context for discussing this issue. The conclusions of this paper with respect to the Martingale property precisely replicate those reached earlier by LeRoy (in [10] and [11]), and not surprisingly, since the economic reasoning in [10] and the present paper is the same. The
4,860 citations
TL;DR: In this paper, the authors derived a single-beta asset pricing model in a multi-good, continuous-time model with uncertain consumption-goods prices and uncertain investment opportunities.
2,667 citations