 Extrapolative Beliefs and Exchange Rate MarketsSarita Bunsupha No 84, PIER Discussion Papers from Puey Ungphakorn Institute for Economic Research Abstract: Following Engel (2016) and Valchev (2015), this paper documents the relationship between interest rate differentials and differential returns on domestic and foreign bonds over time horizon using a broader data sample. I find that countries with higher contemporaneous interest rates earn excess positive bond returns initially in accordance with previous UIP literature. However, the sign of excess returns reverses in the medium run. Higher contemporaneous interest rates predict negative excess returns. Eventually, interest differentials have no excess return predictability. I argue that behavioral bubbles are natural and successful candidates in generating exchange rate dynamics observed in the data. In particular, I propose that investors rely not only on fundamentals (interest differentials) but also extrapolate past exchange rates when forming expectations. The proposed extrapolative model is consistent with both excess return patterns and survey evidence in the data. Keywords: Uncovered Interest Rate Parity; Exchange Rates; Expectations; Extrapolation (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:pui:dpaper:84 Ordering information: This working paper can be ordered from Access Statistics for this paper More papers in PIER Discussion Papers from Puey Ungphakorn Institute for Economic Research Contact information at EDIRC. |
Is your work missing from RePEc? Here is how to contribute.
Questions or problems? Check the EconPapers FAQ or send mail to .
EconPapers is hosted by the
School of Business at Örebro University.