Risk, Policy Rules, and Noise: Rethinking Deviations from Uncovered Interest Parity

Nelson Chung Mark · Yangru Wu

26 citations0/0 files storedRePEc: Research Papers in Economics

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Monetary Policy and Economic Impact Financial Markets and Investment Strategies Economic theories and models

Abstract

This paper investigates why the forward premium predicts the future depreciation with the `wrong' sign and why the unobserved deviation from rational uncovered interest parity is negatively correlated with and is more volatile than the rationally expected depreciation.We examine the ability of three models to account for the data.They are, (i) the standard representative-agent asset pricing model, (ii) a model of monetary-policy with exchange-rate feedback, and (iii) a model of noise trading.Although the noise-trader model is highly stylized, calibrating the model to estimates from the literature analyzing survey expectations produces fragmentary evidence in favor of this approach.

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References

1985Does the Stock Market Overreact?1990Noise Trader Risk in Financial Markets 1984Forward and spot exchange rates 1990Implications of Security Market Data for Models of Dynamic Economies 1995Exchange rates and fundamentals: Evidence on long-horizon predictability 1990Long Swings in the Dollar: Are They in the Data and Do Markets Know It?1996Real Exchange Rate Behavior: The Recent Float from the Perspective of the Past Two Centuries 2002The Message in Daily Exchange Rates

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1998From Worldwide Capital Mobility to International Financial Integration: A Review Essay 2002Some econometric issues in measuring the monetary transmission mechanism, with an application to developing countries 2002The transmission mechanism of monetary policy near zero interest rates: the Japanese experience, 1998–2000

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