Tests of Excess Forecast Volatility in the Foreign Exchange and Stock Markets

Kenneth A. Froot

NBER Working Paper No. 2362
Issued in August 1987
NBER Program(s):   ME   ITI   IFM

Simple regression tests that have power against the alternatives that. asset prices and expected future asset returns are excessively volatile are developed and performed for the foreign exchange and stock markets. These tests have a number of advantages over alternative, variance hounds techniques. We find evidence that. both exchange rates and stock prices are excessively volatile and that expected returns on foreign exchange and stocks move too much. We also investigate whether these findings ran he attributed to time-varying risk premia, but in our tests the data provide little support for such an alternative hypothesis.

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