Advanced Search
MyIDEAS: Login to save this article or follow this journal

Is the forward bias economically small? Evidence from European rates

Contents:

Author Info

  • Sercu, Piet
  • Vandebroek, Martina
  • Wu, Xueping

Abstract

For the purpose of testing uncovered interest parity (UIP), rates of European currencies against the Mark offer a distinct advantage: the admissible band of the Exchange Rate Mechanism (ERM) induces statistically significant mean-reversion in weekly rates. Thus, unlike for freely floating rates, there is an expectation signal that has non-trivial variation and is sufficiently traceable for research purposes. When running the standard regression tests of the unbiased-expectations hypothesis at the one-week horizon, we nevertheless obtain essentially zero coefficients for intra-EMS exchange rates (and the familiar negative coefficients for extra-EMS rates). Even more puzzlingly, lagged exchange-rate changes remain significant when added to the regression, a feature that seems hard to explain as a missing-variable effect. The deviation from UIP is significant not just statistically but also economically: trading-rule tests reveal that for sufficiently large filters the average profit per trade exceeds transaction costs, and that cumulative gains can be quite impressive. The size of the profits and the patterns from buy versus sell decisions also allow us to reject the hypotheses of either a risk premium or peso issues about realignments as sufficient explanations.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.sciencedirect.com/science/article/B6V9S-4SRW0YJ-2/2/dbb40c76b8d80b977c1b1a98fa59c3f0
Download Restriction: Full text for ScienceDirect subscribers only

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Bibliographic Info

Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 27 (2008)
Issue (Month): 8 (December)
Pages: 1284-1302

as in new window
Handle: RePEc:eee:jimfin:v:27:y:2008:i:8:p:1284-1302

Contact details of provider:
Web page: http://www.elsevier.com/locate/inca/30443

Related research

Keywords: Forward bias Transaction costs Trading rule EMS ERM;

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Frans A. de Roon & Theo E. Nijman & Chris Veld, 2000. "Hedging Pressure Effects in Futures Markets," Journal of Finance, American Finance Association, vol. 55(3), pages 1437-1456, 06.
  2. Brandt, Michael W. & Cochrane, John H. & Santa-Clara, Pedro, 2006. "International risk sharing is better than you think, or exchange rates are too smooth," Journal of Monetary Economics, Elsevier, Elsevier, vol. 53(4), pages 671-698, May.
  3. Bong-Chan, Kho, 1996. "Time-varying risk premia, volatility, and technical trading rule profits: Evidence from foreign currency futures markets," Journal of Financial Economics, Elsevier, vol. 41(2), pages 249-290, June.
  4. Bansal, Ravi & Dahlquist, Magnus, 1999. "The Forward Premium Puzzle: Different Tales from Developed and Emerging Economies," CEPR Discussion Papers 2169, C.E.P.R. Discussion Papers.
  5. Lewis, Karen K, 1989. "Changing Beliefs and Systematic Rational Forecast Errors with Evidence from Foreign Exchange," American Economic Review, American Economic Association, vol. 79(4), pages 621-36, September.
  6. O. Miguel Villanueva, 2005. "FX Dynamics, Limited Participation, and the Forward Bias Anomaly," The Financial Review, Eastern Finance Association, Eastern Finance Association, vol. 40(1), pages 67-93, 02.
  7. Hollifield, Burton & Uppal, Raman, 1997. " An Examination of Uncovered Interest Rate Parity in Segmented International Commodity Markets," Journal of Finance, American Finance Association, vol. 52(5), pages 2145-70, December.
  8. Ahn, Dong-Hyun, 2004. "Common Factors and Local Factors: Implications for Term Structures and Exchange Rates," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 39(01), pages 69-102, March.
  9. John F. O. Bilson, 1980. "The "Speculative Efficiency" Hypothesis," NBER Working Papers 0474, National Bureau of Economic Research, Inc.
  10. Geert Bekaert & Robert J. Hodrick, 2000. "Expectations Hypotheses Tests," NBER Working Papers 7609, National Bureau of Economic Research, Inc.
  11. Mayers, David, 1976. "Nonmarketable Assets, Market Segmentation, and the Level of Asset Prices," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 11(01), pages 1-12, March.
  12. Robert E. Cumby & Maurice Obstfeld, 1984. "International Interest Rate and Price Level Linkages under Flexible Exchange Rates: A Review of Recent Evidence," NBER Chapters, in: Exchange Rate Theory and Practice, pages 121-152 National Bureau of Economic Research, Inc.
  13. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, Elsevier, vol. 14(3), pages 319-338, November.
  14. Okunev, John & White, Derek, 2003. "Do Momentum-Based Strategies Still Work in Foreign Currency Markets?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 38(02), pages 425-447, June.
  15. Sercu, Piet & Vandebroek, Martina, 2005. "What UIP tests on extreme samples reveal about the missing variable," Journal of International Money and Finance, Elsevier, Elsevier, vol. 24(8), pages 1237-1260, December.
  16. Christopher J. Neely & Paul A. Weller, 2001. "Intraday technical trading in the foreign exchange market," Working Papers 1999-016, Federal Reserve Bank of St. Louis.
  17. Sweeney, Richard J, 1986. " Beating the Foreign Exchange Market," Journal of Finance, American Finance Association, vol. 41(1), pages 163-82, March.
  18. Bjerring, James H & Lakonishok, Josef & Vermaelen, Theo, 1983. " Stock Prices and Financial Analysts' Recommendations," Journal of Finance, American Finance Association, vol. 38(1), pages 187-204, March.
  19. Huisman, Ronald & Koedijk, Kees & Kool, Clemens & Nissen, Francois, 1998. "Extreme support for uncovered interest parity," Journal of International Money and Finance, Elsevier, Elsevier, vol. 17(1), pages 211-228, February.
  20. Michael J. Brennan & Yihong Xia, 2006. "International Capital Markets and Foreign Exchange Risk," Review of Financial Studies, Society for Financial Studies, vol. 19(3), pages 753-795.
  21. Bansal, Ravi, 1997. "An Exploration of the Forward Premium Puzzle in Currency Markets," Review of Financial Studies, Society for Financial Studies, vol. 10(2), pages 369-403.
  22. Inci, Ahmet Can & Lu, Biao, 2004. "Exchange rates and interest rates: can term structure models explain currency movements?," Journal of Economic Dynamics and Control, Elsevier, vol. 28(8), pages 1595-1624, June.
  23. Lyons, Richard K., 1998. "Profits and position control: a week of FX dealing1," Journal of International Money and Finance, Elsevier, Elsevier, vol. 17(1), pages 97-115, February.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Nath, Golaka, 2013. "The Spot Forward Exchange Rate Relation in Indian Foreign Exchange Market - An Analysis," MPRA Paper 51591, University Library of Munich, Germany.
  2. Pippenger, John, 2011. "A Complete Solution To The Forward-Bias Puzzle," University of California at Santa Barbara, Economics Working Paper Series qt5gq9z4j0, Department of Economics, UC Santa Barbara.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:eee:jimfin:v:27:y:2008:i:8:p:1284-1302. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.