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Can exchange rate volatility explain persistence in the forward premium?

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  • Kellard, Neil
  • Sarantis, Nicholas
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    Abstract

    The persistence of the forward premium has been cited both as evidence of the failure of the unbiasedness hypothesis and as rationale for the forward premium anomaly. This paper examines the recent proposition that forward premium persistence can be explained solely by the conditional variance of the spot rate. We provide theoretical and empirical evidence to challenge this proposition. Our empirical results are shown to be robust to the presence of structural breaks. A corollary of the results is that the 'true' risk premium contains a long memory component. This is non-standard and has implications for the construction of rational expectations models of the foreign exchange market.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Empirical Finance.

    Volume (Year): 15 (2008)
    Issue (Month): 4 (September)
    Pages: 714-728

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    Handle: RePEc:eee:empfin:v:15:y:2008:i:4:p:714-728

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    Web page: http://www.elsevier.com/locate/jempfin

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    Cited by:
    1. Kellard, Neil & Dunis, Christian & Sarantis, Nicholas, 2010. "Foreign exchange, fractional cointegration and the implied-realized volatility relation," Journal of Banking & Finance, Elsevier, vol. 34(4), pages 882-891, April.
    2. Snaith, Stuart & Coakley, Jerry & Kellard, Neil, 2013. "Does the forward premium puzzle disappear over the horizon?," Journal of Banking & Finance, Elsevier, vol. 37(9), pages 3681-3693.
    3. Coakley, Jerry & Dollery, Jian & Kellard, Neil, 2008. "The role of long memory in hedging effectiveness," Computational Statistics & Data Analysis, Elsevier, vol. 52(6), pages 3075-3082, February.

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