Accounting for Forward Rates in Markets for Foreign Currency

David Backus, Allan Gregory and Chris Telmer ()

No 792, Working Paper from Economics Department, Queen's University

Abstract: We examine the behavior of forward and spot exchange rates from the perspective of the representative agent theory of asset pricing. We verify that with moderate risk aversion and time-additive preferences the theory accounts for very little (by our calculations, less than 5 percent) of the variability of expected returns from currency speculation observed for major currencies versus the U.S. dollar. With strong habit persistence, however, the theory can account for one-half to two-thirds of the estimated standard deviation of expected returns from currency speculation. Hansen-Jagannathan bounds imply that the variability of expected returns on currencies, like the equity premium, requires a great deal of variability in intertemporal marginal rates of substitution, some of which is delivered by habit persistence.

Keywords: forward and spot rates; risk premiums; contingent claims pricing; habit persistence; marginal rate of substitution (search for similar items in EconPapers)
Date: 1990-07
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Citations: View citations in EconPapers (5)

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http://qed.econ.queensu.ca/working_papers/papers/qed_wp_792.pdf First version 1990 (application/pdf)

Related works:
Journal Article: Accounting for Forward Rates in Markets for Foreign Currency (1993)
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Persistent link: https://EconPapers.repec.org/RePEc:qed:wpaper:792

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