ACCOUNTING FOR FORWARD RATES IN MARKETS FOR FOREIGN-CURRENCY

Forward and spot exchange rates between major currencies imply large s tandard deviations of both predictable returns from currency speculati on and of the equilibrium price measure (the intertemporal marginal ra te of substitution). Representative agent theory with time-additive pr eferences cannot account for either of these properties. We show that the theory does considerably better along these dimensions when the re presentative agent's preferences exhibit habit persistence, but that t he theory fails to reproduce some of the other properties of the data- in particular, the strong autocorrelation of forward premiums.