Even though the forward-spot relationship in currency markets is very important for policy makers and for corporate and investment managers, it remains a theoretical and empirical puzzle. In theory the forward rate should be an unbiased forecast of the future spot rate, but this hypothesis has little empirical support. For the currencies of the nine major industrialized countries, this paper documents that in spite of the very high trading volumes in currency markets, consistent with evidence for other asset markets, revisions in the forward rate forecasts of the future spot exchange rate reflect systematic pessimism and under-reaction to new information.
... elegant and widely assumed "Rational Expectations" paradigm, markets use all available information e...[2004]). So far, risk premia or other foreign exchange models are unable... to new information in forecasts of inflation (Ball and Croushore [2001]). Karamanou and Raedy (...
In the spring of 2004, there was widespread expectation in financial markets that the Federal Reserve would shortly begin the process of raising its federal funds rate target back toward a more normal level. Much of this concern was based on the sizable increases in long-term rates that occurred when the Federal Reserve tightened monetary policy in 1994-1995 and 1999-2000. In contrast to the conventional wisdom, however, longer-term rates actually declined as the funds rate target rose. This article provides a framework for understanding the relationship between monetary policy and the yield curve that can be used to analyze the behavior of long-term rates during periods of monetary policy tightening. The authors use the framework to examine two recent episodes of policy tightening, in ...
... and long-term interest rates is the expectations theory of the term structure of interest rates. Th... and a term premium to compensate for risk. What this theory implies about nearterm versus di...The expectations hypothesis provides a simple way to link monetary policy acti... to suppress excess demand and inflationary pressures. Thus, short-term rates will be heavily ... expect no change in future policy, term premia may cause long-term rates to be higher than short-...
..., stocks should satisfy the Fisher hypothesis, i.e., the expected inflation coefficient should e...])] (1) where Et-1 is the conditional expectations operator. Boudoukh, Richardson, and Whitelaw (1994...We discuss a microeconomic source of risk premia and relate it to the firm's accounting and market ...
The paper examines whether three international office markets-London City, New York City, and Tokyo CBD-are linked by a long-run relationship. The greater economic and financial market linkages and cross-border capital flows have increased the possibility that the markets are integrated. Johansen tests establish cointegration between total return indices. Hence, London City, New York City, and Tokyo form an equilibrium relationship, deviations from which can prompt portfolio reallocations to exploit opportunities or reduce risk. The findings show that London City adjusts more strongly to the deviations from the long-run path than the other two markets. At the end of 2007, prices in both London City and Tokyo were above equilibrium with Tokyo particularly so, whereas New York City was be...
...Risk premia in integrated markets tend to converge in absolute... future net cash flow (rent growth) expectations, the risk-free rate, and risk premia. Common trend...Global developments such as higher inflation rates may affect one market more than others as th... λ^sub trace^ statistic tests the null hypothesis of at most r cointegrating relationships against t...
Ongoing efforts to find the best method for predicting recessions leave many questions unresolved. One approach with an excellent track record is the term spread model of Estrella and Hardouvelis (1991). When the yield on a three-month Treasury bill rises higher than the yield on a ten-year Treasury note, the model forecasts that a recession will begin twelve months in the future. This article investigates whether changes in the term premium tend to distort the term spread's recession signals. The article begins by decomposing the term spread into an expectations component and a term premium component, based on the Kim and Wright (2005) term premium estimates. Next, the article constructs recession forecasting models based on these components, following the approach of Estrella and Hard...
... predict a recession? The expectations hypothesis posits that long-term interest rates are determine...: Longer term Treasury securities are riskier and require a premium to compensate for this extraa risk. These term premia vary over time as interest rate risk and investors...In turn, each component includes both inflation-related and real factors:. (2) expectations compon...
Powerful real shocks combined to buffet the economy in 2007 and 2008. A combination of a fall in housing wealth from declining house prices and a fall in real income from increasing energy and food prices made individuals worse off. Based on the view that dysfunction in credit markets intensified the recession, monetary policy has focused on intervention into individual credit markets deemed impaired. The spirit of this article is to use empirical generalizations deduced from historical experience and constrained by theory so that they are robust for predicting the consequences of monetary policy. Relevant to current experience is the rapidity with which the economy recovered in the Depression when monetary contraction did not produce a real short-term interest rate in excess of the nat...
..., in late 1973 and early 1974, an inflation shock because of an oil-price rise and the end of ... bankers driven by greed took excessive risks and, in reaction, became excessively risk-averse (... interventions apart from rearranging risk premia among different markets. In December 2008, the rel... over real variables (the natural-rate hypothesis). Nevertheless, monetary instability, which Friedm...It follows that the public's expectations about the future are essential and that a characte...
It has been suggested that prior studies that have puzzlingly found forward rates to be inefficient and biased forecasts of future spot rates may be limited by inadequate statistical methodologies. Using an improved statistical methodology that accounts for both non-stationarity and non-normality in exchange rates, we unfortunately reconfirm that U.S. dollar forward rates for horizons ranging from one to twelve months for the British pound, Japanese yen, Swiss franc, and the German mark over the period 1973-1998 are generally not efficient or rational forecasts of future spot rates. However, as one bright spot, we cannot reject efficiency and rationality for the U.S. dollar forward rate for the Canadian dollar.
...The efficient markets hypothesis (EMH) has played an important role in understandin...It states that if economic agents are risk neutral; all available information is used rationa... information concerning investors' expectations of future spot rates, the forward rates should be ...) correlation between the forward risk premia and expected future spot rates, empirical irregula... influenced by changes in interest and inflation rates differentials and monetary policy changes be...
...The policy implication is that a risk-averse government should issue a "prudent" (i.e., ... to other shocks (e.g., interest rate, inflation, and supply shocks). . We assume throughout this s...Inflation expectations over the short and medium term are based on model-... are determined by the expectations hypothesis of the term structure of interest rates with consttant term premia. For example, the expected real yield on a "m-peri...
... in turn adjusted agents' future expectations. The corresponding volatility in bond markets woul... lengths, and that the expectations hypothesis has performed better at the short end of the yield... national government or implementing an inflation targeting regime. . The paper proceeds as follows....Robins. 1987. Estimating time varying risk premia in the term structure: The Arch-M Model. Ec...
This article provides a detailed introduction to consumption-based bond pricing theory, a special case of the consumption-based asset pricing theory associated with Robert Lucas (1978). To help make the theory more accessible to novices, the authors organize the article around the two famous interest rate decompositions associated with Irving Fisher. According to consumption-based theory, the Fisherian relationships hold exactly only under certain restrictive conditions. The researchers use the modern theory of consumption-based asset pricing, first developed by Robert Lucas (1978), to study bond prices. The pure Fisher relationship states that nominal interest rates are equal to real rates plus expected inflation. Nominal and real interest rates are often viewed from the perspectives o...
... short-term interest rates (the expectations theory of the term structure), and relate short- o... conditions for the pure expectations hypothesis are that households be neutral to risk and the pri.... . call this a nihilistic model of term premia." He views the approach in a positive light, thoug...
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