EXCESS RETURNS IN A SMALL OPEN-ECONOMY

This paper presents detailed analysis of a very unusual event-a recent six-year period during which big excess returns were earned on the sh ort-term interest-bearing assets of a small open economy: Australia. A risk premium does not explain the excess return. Rather than requirin g 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 chan ged nature of the world capital market in the 1980s.