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

Seongman Moon

East Asian Economic Review, 2018, vol. 22, issue 4, 467-505

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 (search for similar items in EconPapers)
JEL-codes: F31 F37 G15 (search for similar items in EconPapers)
Date: 2018
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Persistent link: https://EconPapers.repec.org/RePEc:ris:eaerev:0351

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