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Trends in Expected Returns in Currency and Bond Markets

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  • Evans, M.D.D.
  • Lewis, K.K.

Abstract

Under conventional notions about rational expectations and market efficiency, expected returns differ from the actual expost returns by a forecast error that is uncorrelated with current information. In this paper, we describe how small departures from conventional notions of rational expectations and market efficiency can produce trends in excess returns. These trends are in addition to the trends typically found in the level of asset prices themselves. We report strong evidence for the presence of additional trends in excess foreign exchange and bond returns. We also estimate the additional trend component in excess returns on foreign exchange and find that it varied between -.8% and 1% for one month returns and between -6% and 8% for three month returns.

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Bibliographic Info

Paper provided by Wharton School - Weiss Center for International Financial Research in its series Weiss Center Working Papers with number 93-4.

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Length: 29 pages
Date of creation: 1993
Date of revision:
Handle: RePEc:fth:pennif:93-4

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Keywords: investments ; capital market;

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References

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  1. Kenneth A. Froot, 1987. "New Hope for the Expectations Hypothesis of the Term Structure of Interest Rates," NBER Working Papers 2363, National Bureau of Economic Research, Inc.
  2. Martin D. Evans & Karen K. Lewis, 1992. "Peso Problems and Heterogeneous Trading: Evidence from Excess Returns in Foreign Exchange and Euromarkets," Working Papers 92-13, New York University, Leonard N. Stern School of Business, Department of Economics.
  3. Schwert, G William, 1989. "Tests for Unit Roots: A Monte Carlo Investigation," Journal of Business & Economic Statistics, American Statistical Association, vol. 7(2), pages 147-59, April.
  4. Mishkin, Frederic S., 1992. "Is the Fisher effect for real? : A reexamination of the relationship between inflation and interest rates," Journal of Monetary Economics, Elsevier, vol. 30(2), pages 195-215, November.
  5. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
  6. David M. Cutler & James M. Poterba & Lawrence H. Summers, 1990. "Speculative Dynamics and the Role of Feedback Traders," NBER Working Papers 3243, National Bureau of Economic Research, Inc.
  7. Froot, Kenneth A. & Frankel, Jeffrey A., 1988. "Forward Discount Bias: Is It an Exchange Risk Premium?," Department of Economics, Working Paper Series qt5w65g4zg, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  8. Shiller, Robert & Campbell, John, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," Scholarly Articles 3221490, Harvard University Department of Economics.
  9. John Y. Campbell & Pierre Perron, 1991. "Pitfalls and Opportunities: What Macroeconomists Should Know About Unit Roots," NBER Technical Working Papers 0100, National Bureau of Economic Research, Inc.
  10. Backus, David K. & Gregory, Allan W. & Zin, Stanley E., 1989. "Risk premiums in the term structure : Evidence from artificial economies," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 371-399, November.
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  13. Baillie, R.T. & Bollerslev, T., 1989. "Intra Day And Inter Market Volatility In Foreign Exchange Rates," Papers 8811, Michigan State - Econometrics and Economic Theory.
  14. S. Grossman & R. Shiller, . "The Determinants of the Variability of Stock Market Price," Rodney L. White Center for Financial Research Working Papers 18-80, Wharton School Rodney L. White Center for Financial Research.
  15. Gonzalo, Jesus & Granger, Clive W J, 1995. "Estimation of Common Long-Memory Components in Cointegrated Systems," Journal of Business & Economic Statistics, American Statistical Association, vol. 13(1), pages 27-35, January.
  16. De Long, J Bradford, et al, 1990. " Positive Feedback Investment Strategies and Destabilizing Rational Speculation," Journal of Finance, American Finance Association, vol. 45(2), pages 379-95, June.
  17. Baillie, Richard T & Bollerslev, Tim, 1989. " Common Stochastic Trends in a System of Exchange Rates," Journal of Finance, American Finance Association, vol. 44(1), pages 167-81, March.
  18. Francis X. Diebold & Marc Nerlove, 1988. "Unit roots in economic time series: a selective survey," Finance and Economics Discussion Series 49, Board of Governors of the Federal Reserve System (U.S.).
  19. Engel, Charles & Hamilton, James D, 1990. "Long Swings in the Dollar: Are They in the Data and Do Markets Know It?," American Economic Review, American Economic Association, vol. 80(4), pages 689-713, September.
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Cited by:
  1. Christodoulakis, Nicos M. & Kalyvitis, Sarantis C., 1997. "Efficiency testing revisited: a foreign exchange market with Bayesian learning," Journal of International Money and Finance, Elsevier, vol. 16(3), pages 367-385, June.
  2. Chang-Jin Kim & Jeremy Piger & Richard Startz, 2003. "The Dynamic Relationship Between Permanent and Transitory Components of U.S. Business Cycle," Working Papers UWEC-2003-36, University of Washington, Department of Economics.
  3. Kim, Chang-Jin & Piger, Jeremy, 2002. "Common stochastic trends, common cycles, and asymmetry in economic fluctuations," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1189-1211, September.
  4. Charles Nelson & Eric Zivot & Jeremy M. Piger, 2001. "Markov regime switching and unit root tests," Working Papers 2001-013, Federal Reserve Bank of St. Louis.
  5. Chang-Jin Kim & Jeremy Piger & Richard Startz, 2001. "Permanent and transitory components of business cycles: their relative importance and dynamic relationship," International Finance Discussion Papers 703, Board of Governors of the Federal Reserve System (U.S.).
  6. Charles Nelson & Jeremy Piger & Eric Zivot, 1999. "Unit Root Tests in the Presence of Markov Regime-Switching," Working Papers 0040, University of Washington, Department of Economics.
  7. Nagayasu, Jun, 2010. "The Common Component in the Forward Premium: Evidence from the Asia-Pacific Region," MPRA Paper 24549, University Library of Munich, Germany.

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