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Covered Purchasing Power Parity, Ex-Ante PPP and Risk Aversion

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  • Moore, Michael J

Abstract

The standard expectations augmented theory of ex-ante purchasing power parity (PPP), which was first developed by Roll, assumes that agents are risk neutral. A Covered Purchasing Power Condition is developed which holds for the general case of risk aversion. A risk-augmented form of ex-ante PPP is then derived using a Lucas-style asset pricing framework. From this I conclude that real exchange rates may not possess the martingale property though the analysis clarifies the circumstances under which this property does hold.A consumption-based orthogonality condition is tested for, using 1970s and 1980s data for the seven main industrial countries. An interesting by-product of the study is that it provides us with a useful example of unit root testing on seasonal data. Overall the results give rise to cautious optimism.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 635.

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Date of creation: Apr 1992
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Handle: RePEc:cpr:ceprdp:635

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Keywords: Arbitrage; Purchasing Power Parity; Risk Aversion;

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Cited by:
  1. Moore, Michael J. & Roche, Maurice J., 2002. "Less of a puzzle: a new look at the forward forex market," Journal of International Economics, Elsevier, vol. 58(2), pages 387-411, December.
  2. Maurice J. Roche & Michael J. Moore, 2009. "Solving Exchange Rate Puzzles with neither Sticky Prices nor Trade Costs," Working Papers 001, Ryerson University, Department of Economics.
  3. Maria Perez Jurado & Juan Luis Vega, 1994. "Paridad del poder de compra: un análisis empírico," Investigaciones Economicas, Fundación SEPI, vol. 18(3), pages 539-556, September.

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