Do Foreign Excess Return Regressions Convey Valid Information?

This paper shows that the estimates in the spot return regression in the foreign exchange markets may not convey valid information if exchange rates are generated from the present value model with the near unit discount factor and unit root fundamentals. The main reason is that the present value model generates a large magnitude of a bias in the estimation of the regression accompanied by a wide distribution of the estimates. On the other hand, the implications of the present value model for the volatility and persistence of the spot return and the forward premium are consistent with the data.