Assessing the Efficiency of Asset Markets through Analysis of the Currency Carry Trade

In a globally competitive world, capital market efficiency requires that investors seek out the highest risk-adjusted expected rates of return throughout the world. Capital should flow from countries with weaker investment prospects to countries with better investment prospects. Asset markets provide valuation cues to investors who move the capital. Monetary and fiscal policies affect interest rates, exchange rates, and other asset prices thereby influencing these investment decisions. Policymakers also base their decisions on observed asset prices. Given the important role asset prices play, everyone wonders whether asset markets provide the right cues for both investors and policymakers.