Date of Award

Spring 2014

Degree Name

Bachelor of Science

Major

Economics

First Advisor

Professor Josh R. Stillwagon

Abstract

This paper finds further evidence using a Cointegrated Vector Autoregression to support claims against the Uncovered Interest Rate Parity (UIP) ex post, referred to as the Forward Discount Anomaly (Fama, 1984). This anomaly suggests predictable profits simply from investing in a country with a higher interest rate. Potential explanations could be attributed to risk or deviations from the rational expectations hypothesis. UIP ex ante is tested using survey data. These results indicate a time-­‐ varying risk premium. Further it is found that this premium is related to the gap between the exchange rate and Purchasing-­‐Power-­‐Parity value. Additionally it is determined that investor expectations are consistent with some behavioral rules; extrapolative and adaptive expectations drive deviations from PPP which transitions to regressive expectations when the gap is very large.

Comments

Senior Thesis completed at Trinity College for the degree of Bachelor of Science in Economics.