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A Random Walk Around the $A: Expectations, Risk, Interest Rates and Consequences for External Imbalance

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Author Info

  • Jeremy Smith

    (Australian National University)

  • David W.R. Gruen

    (Reserve Bank of Australia)

Abstract

Given essentially perfect capital mobility, Australian interest rates and the expected exchange rate change should satisify international arbitrage conditions. We examine an arbitrage condition for a US investor, with a view to explaining the large short-term real interest differential between Australia and the US since late 1984. We have some evidence for a risk premium until late 1985. Since then, we explain the differential as a result of foreign exchange market inefficiency or as a consequence of the market having continually and rationally expected significant real devaluation of the $A. We provide evidence for both these explanations and draw implications for the current debate on Australia’s external imbalance.

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Bibliographic Info

Paper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp8906.

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Date of creation: Oct 1989
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Handle: RePEc:rba:rbardp:rdp8906

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Cited by:
  1. Douglas, Justin J. & Bartley, Scott W., 1997. "Risk premia in Australian interest rates," Australian Journal of Agricultural and Resource Economics, Australian Agricultural and Resource Economics Society, vol. 41(2), June.
  2. G. C. Lim & C. R. McKenzie, 1998. "Testing the rationality of expectations in the Australian foreign exchange market using survey data with missing observations," Applied Financial Economics, Taylor & Francis Journals, vol. 8(2), pages 181-190.

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