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Accounting for Forward Rates in Markets for Foreign Currency

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Author Info

  • David K. Backus
  • Allan W. Gregory
  • Chris I. Telmer

Abstract

Forward and spot exchange rates between major currencies imply large standard deviations of both predictable returns from currency speculation and of the equilibrium price measure (the intertemporal marginal rate of substitution). Representative agent theory with time-additive preferences cannot account for either of these properties. The authors show that the theory does considerably better along these dimensions when the representative agent's preferences exhibit habit persistence but that the theory fails to reproduce some of the other properties of the data--in particular, the strong autocorrelation of forward premiums. Copyright 1993 by American Finance Association.

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Bibliographic Info

Paper provided by New York University, Leonard N. Stern School of Business, Department of Economics in its series Working Papers with number 92-18b.

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Date of creation: Apr 1992
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Handle: RePEc:ste:nystbu:92-18b

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Postal: New York University, Leonard N. Stern School of Business, Department of Economics, 44 West 4th Street, New York, NY 10012-1126
Phone: (212) 998-0860
Fax: (212) 995-4218
Web page: http://w4.stern.nyu.edu/economics/
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