Rational Expectations, Risk Premia, and the Market for Spot and Forward Exchange

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Abstract
Implicit in models of exchange rate determination that ssume markets for spot and forward rates are "efficient" are the assumptions of rational expectations, costless transactions, risk neutral market participants, and the absence of legal restrictions on transactions. Since these assumptions do not literally descrive the foreign echange market, the efficiency hypothesis also cannot be literally true. While this observation alone does not imply that the efficient markets model is poor approximation to the true model, the recent emirical studies of Geweke and Feige (1979), Hakkio (1979), and Hansen and Hodrick (1980a, b) suggect that there have been significant departures from efficiency during the 1970's.

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