IDEAS home Printed from https://ideas.repec.org/a/bla/ecorec/v70y1994i211p381-396.html

Excess Returns in a Small Open Economy

Author

Listed:
  • DAVID W. R. GRUEN
  • JEREMY SMITH

Abstract

This paper presents detailed analysis of a very unusual event —a recent six‐year period during which big excess returns were earned on the short‐term interest‐bearing assets of a small open economy: Australia. A risk premium does not explain the excess return. Rather than requiring a risk premium, market participants continually expected significant real depreciation of the Australian dollar, despite the fact that on average it appreciated in real terms. Our results may be a consequence of the foreign exchange market only gradually learning about the changed nature of the world capital market in the 1980s.

Suggested Citation

  • David W. R. Gruen & Jeremy Smith, 1994. "Excess Returns in a Small Open Economy," The Economic Record, The Economic Society of Australia, vol. 70(211), pages 381-396, December.
    • Handle: RePEc:bla:ecorec:v:70:y:1994:i:211:p:381-396
    DOI: 10.1111/j.1475-4932.1994.tb01857.x
    as

    Download full text from publisher

    File URL: https://doi.org/10.1111/j.1475-4932.1994.tb01857.x
    Download Restriction: no
    File URL: https://libkey.io/10.1111/j.1475-4932.1994.tb01857.x?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Cecchetti, Stephen G & Mark, Nelson C, 1990. "Evaluating Empirical Tests of Asset Pricing Models: Alternative Interpretations," American Economic Review, American Economic Association, vol. 80(2), pages 48-51, May.
    2. Hodrick, Robert J. & Srivastava, Sanjay, 1984. "An investigation of risk and return in forward foreign exchange," Journal of International Money and Finance, Elsevier, vol. 3(1), pages 5-29, April.
    3. Nelson, Daniel B, 1991. "Conditional Heteroskedasticity in Asset Returns: A New Approach," Econometrica, Econometric Society, vol. 59(2), pages 347-370, March.
    4. Henriksson, Roy D & Merton, Robert C, 1981. "On Market Timing and Investment Performance. II. Statistical Procedures for Evaluating Forecasting Skills," The Journal of Business, University of Chicago Press, vol. 54(4), pages 513-533, October.
    5. Kenneth A. Froot & Jeffrey A. Frankel, 1989. "Forward Discount Bias: Is it an Exchange Risk Premium?," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 104(1), pages 139-161.
    6. David W.R. Gruen, 1991. "The Effect of Steady Inflation on Interest Rates and the Real Exchange Rate in a World with Free Capital Flows," RBA Research Discussion Papers rdp9101, Reserve Bank of Australia.
    7. Pagan, Adrian R. & Schwert, G. William, 1990. "Alternative models for conditional stock volatility," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 267-290.
    8. Frankel, Jeffrey A., 1983. "Estimation of portfolio-balance functions that are mean-variance optimizing : The mark and the dollar," European Economic Review, Elsevier, vol. 23(3), pages 315-327, September.
    9. Frankel, Jeffrey A & Chinn, Menzie D, 1993. "Exchange Rate Expectations and the Risk Premium: Tests for a Cross Section of 17 Currencies," Review of International Economics, Wiley Blackwell, vol. 1(2), pages 136-144, June.
    10. Froot, Kenneth A & Thaler, Richard H, 1990. "Foreign Exchange," Journal of Economic Perspectives, American Economic Association, vol. 4(3), pages 179-192, Summer.
    11. Frankel, Jeffrey A. & MacArthur, Alan T., 1988. "Political vs. currency premia in international real interest differentials : A study of forward rates for 24 countries," European Economic Review, Elsevier, vol. 32(5), pages 1083-1114, June.
    12. Frankel, Jeffrey A., 1986. "The implications of mean-variance optimization for four questions in international macroeconomics," Journal of International Money and Finance, Elsevier, vol. 5(1, Supple), pages 53-75, March.
    13. Frankel, Jeffrey & Engel, Charles M., 1984. "Do asset-demand functions optimize over the mean and variance of real returns? A six-currency test," Journal of International Economics, Elsevier, vol. 17(3-4), pages 309-323, November.
    14. Adrian Blundell-Wignall & Robert G. Gregory, 1990. "Exchange Rate Policy in Advanced Commodity-Exporting Countries: The Case of Australia and New Zealand," OECD Economics Department Working Papers 83, OECD Publishing.
    15. Cumby, Robert E., 1988. "Is it risk? : Explaining deviations from uncovered interest parity," Journal of Monetary Economics, Elsevier, vol. 22(2), pages 279-299, September.
    16. repec:bla:econom:v:55:y:1988:i:220:p:437-60 is not listed on IDEAS
    17. So, Jacky C, 1987. "The Distribution of Foreign Exchange Price Changes: Trading Day Effects and Risk Measurement--A Comment," Journal of Finance, American Finance Association, vol. 42(1), pages 181-188, March.
    18. Jeremy Smith & David W.R. Gruen, 1989. "A Random Walk Around the $A: Expectations, Risk, Interest Rates and Consequences for External Imbalance," RBA Research Discussion Papers rdp8906, Reserve Bank of Australia.
    19. M. Manzur, 1988. "How Much are Exchange Rate Forecasts Worth?," Economics Discussion / Working Papers 88-18, The University of Western Australia, Department of Economics.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Tom Crowards, 2002. "Defining the category of 'small' states," Journal of International Development, John Wiley & Sons, Ltd., vol. 14(2), pages 143-179.
    2. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.
    3. Smith, Jeremy & Yadav, Sanjay, 1996. "A comparison of alternative covariance matrices for models with over-lapping observations," Journal of International Money and Finance, Elsevier, vol. 15(5), pages 813-823, October.
    4. Mardi Dungey & Adrian Pagan, 2000. "A Structural VAR Model of the Australian Economy," The Economic Record, The Economic Society of Australia, vol. 76(235), pages 321-342, December.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Gruen, D.W.R. & Gizycki, M.C., 1993. "Explaining Forward Discount Bias: Is It Anchoring?," Papers 164, Princeton, Woodrow Wilson School - Public and International Affairs.
    2. Engel, Charles, 1996. "The forward discount anomaly and the risk premium: A survey of recent evidence," Journal of Empirical Finance, Elsevier, vol. 3(2), pages 123-192, June.
    3. Coelho dos Santos, Marcelo Bittencourt & Klotzle, Marcelo Cabus & Figueiredo Pinto, Antonio Carlos, 2016. "Evidence of risk premiums in emerging market carry trade currencies," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 44(C), pages 103-115.
    4. David W.R. Gruen & Gordon D. Menzies, 1991. "The Failure of Uncovered Interest Parity: Is it Near-rationality in the Foreign Exchange Market?," RBA Research Discussion Papers rdp9103, Reserve Bank of Australia.
    5. Lewis, Karen K., 1995. "Puzzles in international financial markets," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 37, pages 1913-1971, Elsevier.
    6. Vitale, Paolo & Rime, Dagfinn & Breedon, Francis, 2010. "A Transaction Data Study of the Forward Bias Puzzle," CEPR Discussion Papers 7791, C.E.P.R. Discussion Papers.
    7. Francis Breedon & Dagfinn Rime & Paolo Vitale, 2016. "Carry Trades, Order Flow, and the Forward Bias Puzzle," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 48(6), pages 1113-1134, September.
    8. Mark, Nelson C & Wu, Yangru, 1998. "Rethinking Deviations from Uncovered Interest Parity: The Role of Covariance Risk and Noise," Economic Journal, Royal Economic Society, vol. 108(451), pages 1686-1706, November.
    9. 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), pages 1-35.
    10. Francis Breedon & Dagfinn Rime & Paolo Vitale, 2016. "Carry Trades, Order Flow, and the Forward Bias Puzzle," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 48(6), pages 1113-1134, September.
    11. Menzie Chinn & Jeffery Frankel, 1995. "More survey data on exchange rate expectations: More currencies, more horizons, more tests," International Finance 9508003, University Library of Munich, Germany.
    12. Tim Bollerslev & Ray Y. Chou & Narayanan Jayaraman & Kenneth F. Kroner - L, 1991. "es modéles ARCH en finance : un point sur la théorie et les résultats empiriques," Annals of Economics and Statistics, GENES, issue 24, pages 1-59.
    13. Bollerslev, Tim & Chou, Ray Y. & Kroner, Kenneth F., 1992. "ARCH modeling in finance : A review of the theory and empirical evidence," Journal of Econometrics, Elsevier, vol. 52(1-2), pages 5-59.
    14. David W. R. Gruen & Gordon D. Menzies, 1995. "Forward Discount Bias: Is it Near‐Rationality in the Foreign Exchange Market?," The Economic Record, The Economic Society of Australia, vol. 71(2), pages 157-166, June.
    15. repec:osu:osuewp:014 is not listed on IDEAS
    16. repec:adr:anecst:y:1991:i:24:p:01 is not listed on IDEAS
    17. Ross Levine, 1988. "The forward exchange rate bias: a new explanation," International Finance Discussion Papers 338, Board of Governors of the Federal Reserve System (U.S.).
    18. Emmanuel Farhi & Xavier Gabaix, "undated". "Rare Disasters and Exchange Rates," Working Paper 71001, Harvard University OpenScholar.
    19. Stuart Landon & Constance E. Smith, 2003. "The Risk Premium, Exchange Rate Expectations, and the Forward Exchange Rate: Estimates for the Yen–Dollar Rate," Review of International Economics, Wiley Blackwell, vol. 11(1), pages 144-158, February.
    20. Nelson Mark & Young-Kyu Moh, 2003. "Official Interventions and Occasional Violations of Uncovered Interest Party in the Dollar-DM Market," NBER Working Papers 9948, National Bureau of Economic Research, Inc.
    21. Jeffrey A. Frankel, 1985. "International capital mobility and crowding-out in the U.S. economy: imperfect integration of financial markets or of goods markets?," Proceedings, Federal Reserve Bank of St. Louis, pages 33-74.
    22. Zigraiova, Diana & Havranek, Tomas & Irsova, Zuzana & Novak, Jiri, 2021. "How puzzling is the forward premium puzzle? A meta-analysis," European Economic Review, Elsevier, vol. 134(C).

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bla:ecorec:v:70:y:1994:i:211:p:381-396. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley Content Delivery (email available below). General contact details of provider: https://edirc.repec.org/data/esausea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.