Journal of International Financial Management and Accounting
This paper utilizes the concept of aggregative consistency defined in Rubinstein and Fishburn [1986], and the FASB's concept of representational faithfulness to evaluate foreign currency translation and accounting for changing prices as embodied in SFAS 70. The paper shows that SFAS 70 produces measurement errors and creates a foreign currency translation adjustment which does not reflect the effects of exchange rate changes. The conditions defined in the paper also facilitate an evaluation of the relative merits of restate/translate and translate/restate.
This paper is motivated by two facts: failure of log-linear empirical exchange rate models of the 1970's and the observed variability of risk premiums in the forward market. Rational maximizing models predict that changes in conditional variances of monetary policies, government spendings, and income growths affect risk premiums and induce conditional volatility of exchange rates.
Written for graduate students, researchers and professionals in international finance and academia, this book provides a useful foundation for future research in developing quantitative measures of risk and expected return in international finance. After a discussion of a general rational expectations asset pricing model, Hodrick considers the development and implementation of econometric tests of various hypotheses that have been offered as candidate characterizations of efficiency in foreign exchange markets.
