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Does the Forward Premium/Discount Help to Predict the Future Change in the Exchange Rate?

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  • Goodhart, Charles A E
  • McMahon, Patrick C
  • Ngama, Yerima Lawan
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    Abstract

    This paper reexamines the relationship between the spot exchange rate depreciation and the forward premium. Many researchers report a negative, and occasionally significant, coefficient when the spot depreciation is regressed on the forward premium. The authors' analysis reveals that such findings are due to the presence of structural breaks and/or outliers in the data. After allowing for these, the forward premium has no information at all about the future change in the spot exchange rate. This finding is a direct implication of the spot rate being, approximately, a random walk and the covered interest parity holding. Copyright 1992 by Scottish Economic Society.

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    Bibliographic Info

    Article provided by Scottish Economic Society in its journal Scottish Journal of Political Economy.

    Volume (Year): 39 (1992)
    Issue (Month): 2 (May)
    Pages: 129-40

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    Handle: RePEc:bla:scotjp:v:39:y:1992:i:2:p:129-40

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    Cited by:
    1. Engel, Charles, 1996. "The forward discount anomaly and the risk premium: A survey of recent evidence," Journal of Empirical Finance, Elsevier, Elsevier, vol. 3(2), pages 123-192, June.
    2. Bell, Adrian R. & Brooks, Chris & Dryburgh, Paul, 2007. "Interest rates and efficiency in medieval wool forward contracts," Journal of Banking & Finance, Elsevier, Elsevier, vol. 31(2), pages 361-380, February.
    3. Pippenger, John E, 2009. "The Forward-Bias Puzzle: A Solution Based on Covered Interest Parity," University of California at Santa Barbara, Economics Working Paper Series qt05d0t24b, Department of Economics, UC Santa Barbara.
    4. Peter C.B. Phillips & James W. McFarland, 1993. "Forward Exchange Market Unbiasedness: The Case of the Australian Dollar Since 1984," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 1055, Cowles Foundation for Research in Economics, Yale University, revised 1996.
    5. Choudhry, Taufiq, 1999. "Re-examining forward market efficiency Evidence from fractional and Harris-Inder cointegration tests," International Review of Economics & Finance, Elsevier, Elsevier, vol. 8(4), pages 433-453, November.
    6. Angelos Kanas & Christos Ioannidis, 2012. "Revisiting the forward—spot relation: an application of the nonparametric long-run correlation coefficient," Journal of Economics and Finance, Springer, Springer, vol. 36(1), pages 148-161, January.
    7. Pippenger, John E, 2010. "The Solution to the Forward-Bias and Related Puzzles," University of California at Santa Barbara, Economics Working Paper Series qt6br3599r, Department of Economics, UC Santa Barbara.
    8. Neslihan Topbas, 2014. "Tests of Rationality in Turkish Foreign Exchange Market," Central Bank Review, Research and Monetary Policy Department, Central Bank of the Republic of Turkey, vol. 14(2), pages 65-78.
    9. Pippenger, John, 2009. "The Forward-Bias Puzzle: A Solution Based on Covered Interest Parity," University of California at Santa Barbara, Economics Working Paper Series qt4dd1075r, Department of Economics, UC Santa Barbara.
    10. Cover, James P. & Mallick, Sushanta K., 2012. "Identifying sources of macroeconomic and exchange rate fluctuations in the UK," Journal of International Money and Finance, Elsevier, Elsevier, vol. 31(6), pages 1627-1648.
    11. Detken, Carsten & Gaspar, Vítor, 2003. "Maintaining price stability under free-floating: a fearless way out of the corner?," Working Paper Series, European Central Bank 0241, European Central Bank.
    12. G. C. Lim & C. R. McKenzie, 1998. "Testing the rationality of expectations in the Australian foreign exchange market using survey data with missing observations," Applied Financial Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 8(2), pages 181-190.

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