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Expected Currency Excess Returns and International Business Cycles

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  • Sanglim Lee

    (University of Connecticut)

Abstract

It is well known that the uncovered interest parity condition does not hold empirically, implying that investments in high-interest rate currencies in foreign currency markets result in a positive expected excess return. Verdelhan (2010) successfully explains this phenomenon by referring to exogenous consumption processes and external habit formation. In this paper, I extend his model by using an international real business cycle model (Backus, Kehoe, and Kydland 1994) with internal habit formation. When the production-based stochastic discount factor is used, this benchmark model, driven by total factor productivity, accounts for this empirical evidence as well. JEL Classification: E32, E44, F31, F44 Key words: Currency Excess Return, Real Business Cycle, Forward Premium Puzzle

Suggested Citation

  • Sanglim Lee, 2012. "Expected Currency Excess Returns and International Business Cycles," Working papers 2012-16, University of Connecticut, Department of Economics.
    • Handle: RePEc:uct:uconnp:2012-16
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    References listed on IDEAS

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    5. Frankel, Jeffrey & Poonawala, Jumana, 2010. "The forward market in emerging currencies: Less biased than in major currencies," Journal of International Money and Finance, Elsevier, vol. 29(3), pages 585-598, April.
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    More about this item

    Keywords

    currency excess return; real business cycle; forward premium puzzle;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles

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