Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/189117
Authors: 
Backus, David K.
Gregory, Allan W.
Telmer, Chris I.
Year of Publication: 
1990
Series/Report no.: 
Queen's Economics Department Working Paper 792
Abstract: 
We examine the behavior of forward and spot exchange rates from the perspective of the representative agent theory of asset pricing. We verify that with moderate risk aversion and time-additive preferences the theory accounts for very little (by our calculations, less than 5 percent) of the variability of expected returns from currency speculation observed for major currencies versus the U.S. dollar. With strong habit persistence, however, the theory can account for one-half to two-thirds of the estimated standard deviation of expected returns from currency speculation. Hansen-Jagannathan bounds imply that the variability of expected returns on currencies, like the equity premium, requires a great deal of variability in intertemporal marginal rates of substitution, some of which is delivered by habit persistence.
Subjects: 
forward and spot rates
risk premiums
contingent claims pricing
habit persistence
marginal rate of substitution
JEL: 
431
521
Document Type: 
Working Paper
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