Several recent empirical studies have been forced to reject exact 1:1 cointegration between spot and forward exchange rates. Theoretically, this is shown to provide a possible explanation for the puzzling negative estimates reported from spot-return-forward-premium regressions. In particular, the coefficient in this regression has a unit root component in its limit distribution that imparts a bias and skewness to the estimator. Simulations are used to demonstrate how even very small deviations from 1:1 cointegration can result in substantial bias. The empirical evidence suggests that the implied Dickey-Fuller-type terms do exhibit a downward bias, yet are of insufficient magnitude to fully account for the puzzling regression coefficients mentioned above. Copyright (c) 2003 President and Fellows of Harvard College and the Massachusetts Institute of Technology.
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Craig Burnside & Martin Eichenbaum & Isaac Kleshchelski & Sergio Rebelo, 2006.
"The Returns to Currency Speculation,"
NBER Working Papers
12489, National Bureau of Economic Research, Inc.
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