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Trends in Expected Returns in Currency and Bond Markets

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  • Martin D. Evans
  • Karen K. Lewis

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 National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4116.

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Date of creation: Jul 1992
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Publication status: published as European Economic Review, vol. 37, June 1993, pp. 1005-1020
Handle: RePEc:nbr:nberwo:4116

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  1. John Y. Campbell & Robert J. Shiller, 1989. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," NBER Working Papers 3153, National Bureau of Economic Research, Inc.
  2. Baillie, R.T. & Bollerslev, T., 1989. "Intra Day And Inter Market Volatility In Foreign Exchange Rates," Papers, Michigan State - Econometrics and Economic Theory 8811, Michigan State - Econometrics and Economic Theory.
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  5. Froot, Kenneth A, 1989. " New Hope for the Expectations Hypothesis of the Term Structure of Interest Rates," Journal of Finance, American Finance Association, American Finance Association, vol. 44(2), pages 283-305, June.
  6. Froot, Kenneth A. & Frankel, Jeffrey A., 1988. "Forward Discount Bias: Is It an Exchange Risk Premium?," Department of Economics, Working Paper Series, Department of Economics, Institute for Business and Economic Research, UC Berkeley qt5w65g4zg, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  7. Martin D. Evans & Karen K. Lewis, 1992. "Peso Problems and Heterogeneous Trading: Evidence From Excess Returns in Foreign Exchange and Euromarkets," NBER Working Papers 4003, National Bureau of Economic Research, Inc.
  8. John Y. Campbell & Pierre Perron, 1991. "Pitfalls and Opportunities: What Macroeconomists Should Know About Unit Roots," NBER Chapters, in: NBER Macroeconomics Annual 1991, Volume 6, pages 141-220 National Bureau of Economic Research, Inc.
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  14. 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, American Economic Association, vol. 80(4), pages 689-713, September.
  15. Gonzalo, J. & Granger, C., 1992. "Estimation of Common Long-Memory Components in Cointegrated Systems," Papers, Boston University - Department of Economics 4, Boston University - Department of Economics.
  16. Meese, Richard A & Singleton, Kenneth J, 1982. " On Unit Roots and the Empirical Modeling of Exchange Rates," Journal of Finance, American Finance Association, American Finance Association, vol. 37(4), pages 1029-35, September.
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  19. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, Elsevier, vol. 14(1-2), pages 3-24, February.
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Cited by:
  1. Chang-Jin Kim & Jeremy M. Piger, 2001. "Common stochastic trends, common cycles, and asymmetry in economic fluctuations," Working Papers, Federal Reserve Bank of St. Louis 2001-014, Federal Reserve Bank of St. Louis.
  2. Chang-Jin Kim & Jeremy M. Piger & Richard Startz, 2007. "The Dynamic Relationship between Permanent and Transitory Components of U.S. Business Cycles," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 39(1), pages 187-204, 02.
  3. Charles Nelson & Jeremy Piger & Eric Zivot, 1999. "Unit Root Tests in the Presence of Markov Regime-Switching," Working Papers, University of Washington, Department of Economics 0040, University of Washington, Department of Economics.
  4. 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, Board of Governors of the Federal Reserve System (U.S.) 703, Board of Governors of the Federal Reserve System (U.S.).
  5. Nelson, Charles R & Piger, Jeremy & Zivot, Eric, 2001. "Markov Regime Switching and Unit-Root Tests," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 19(4), pages 404-15, October.
  6. Christodoulakis, Nicos M. & Kalyvitis, Sarantis C., 1997. "Efficiency testing revisited: a foreign exchange market with Bayesian learning," Journal of International Money and Finance, Elsevier, Elsevier, vol. 16(3), pages 367-385, June.
  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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