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Covered Purchasing Power Parity, Ex-Ante PPP and Risk Aversion

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  • Moore, Michael J

Abstract

The standard expectations augmented theory of ex-ante purchasing power parity (PPP), which was first developed by Roll, assumes that agents are risk neutral. A Covered Purchasing Power Condition is developed which holds for the general case of risk aversion. A risk-augmented form of ex-ante PPP is then derived using a Lucas-style asset pricing framework. From this I conclude that real exchange rates may not possess the martingale property though the analysis clarifies the circumstances under which this property does hold.A consumption-based orthogonality condition is tested for, using 1970s and 1980s data for the seven main industrial countries. An interesting by-product of the study is that it provides us with a useful example of unit root testing on seasonal data. Overall the results give rise to cautious optimism.

Suggested Citation

  • Moore, Michael J, 1992. "Covered Purchasing Power Parity, Ex-Ante PPP and Risk Aversion," CEPR Discussion Papers 635, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:635
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    Cited by:

    1. Moore, Michael J. & Roche, Maurice J., 2010. "Solving exchange rate puzzles with neither sticky prices nor trade costs," Journal of International Money and Finance, Elsevier, vol. 29(6), pages 1151-1170, October.
    2. Moore, Michael J. & Roche, Maurice J., 2002. "Less of a puzzle: a new look at the forward forex market," Journal of International Economics, Elsevier, vol. 58(2), pages 387-411, December.
    3. Maria Perez Jurado & Juan Luis Vega, 1994. "Paridad del poder de compra: un análisis empírico," Investigaciones Economicas, Fundación SEPI, vol. 18(3), pages 539-556, September.

    More about this item

    Keywords

    Arbitrage; Purchasing Power Parity; Risk Aversion;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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