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Lesson_59_Expectations - Expectations When investors...

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1 Lesson 59 1 Expectations When investors re-assess their belief regarding the future, the impact is felt immediately in the spot market This lesson shows how to incorporate expectations into a model of exchange rate determination Lesson 59 2 We start with the same assumptions last time (two assets, single interest rate in each country) Let E e represent the expectation of what the spot exchange rate will be in the future The expected rate of appreciation of the foreign currency is e E E E Lesson 59 3 Remember, if the foreign currency is expected to appreciate , the dollar is expected to depreciate If this expression is negative, the expected rate of appreciation is negative….i.e., the foreign currency is expected to depreciate! An investor who might not be concerned with exchange risk may be willing to take an uncovered position
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2 Lesson 59 4 An investor who doesn’t care about risk is said to be risk neutral Care only about expected return If investors are risk neutral, we have the uncovered interest parity condition: * e E E i i E = + Lesson 59
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