Forward Discount Bias, Nalebuff's Envelope Puzzle, and the Siegel Paradox in Foreign Exchange
AbstractThe bias of forward exchange rates as a predictor of future spot rates is typically explained or decomposed as (1) a risk premium and (2) a convexity term which accounts for the fact that, when there is stochastic inflation, nominal gains from forward currency speculation are higher than real ones and correspondingly losses are smaller. We use Nalebuff's envelope puzzle to explain a third source of bias which involves real profits from foreign exchange speculation. Both the "real profit" bias and stochastic inflation bias arise from convexity of g(s)=1/s and so derive from Jensen's inequality as observed by Siegel (1972).
Download InfoIf 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.
Bibliographic InfoPaper provided by Berkeley Olin Program in Law & Economics in its series Berkeley Olin Program in Law & Economics, Working Paper Series with number qt2wc1p9pw.
Date of creation: 01 Jun 2002
Date of revision:
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.:
- Kenneth A. Froot and Jeffrey A. Frankel., 1988.
"Forward Discount Bias: Is It an Exchange Risk Premium?,"
Economics Working Papers
8874, University of California at Berkeley.
- Froot, Kenneth A & Frankel, Jeffrey A, 1989. "Forward Discount Bias: Is It an Exchange Risk Premium?," The Quarterly Journal of Economics, MIT Press, vol. 104(1), pages 139-61, February.
- Froot, Kenneth A. & Frankel, Jeffrey A., 1988. "Forward Discount Bias: Is It an Exchange Risk Premium?," Department of Economics, Working Paper Series qt5w65g4zg, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
- Sinn, Hans-Werner, 1989. "Expected utility and the Siegel paradox," Munich Reprints in Economics 19849, University of Munich, Department of Economics.
- Grauer, Frederick L. A. & Litzenberger, Robert H. & Stehle, Richard E., 1976. "Sharing rules and equilibrium in an international capital market under uncertainty," Journal of Financial Economics, Elsevier, vol. 3(3), pages 233-256, June.
- McCulloch, J Huston, 1975. "Operational Aspects of the Siegel Paradox: Comment," The Quarterly Journal of Economics, MIT Press, vol. 89(1), pages 170-72, February.
- Tiff Macklem, R., 1991. "Forward exchange rates and risk premiums in artificial economies," Journal of International Money and Finance, Elsevier, vol. 10(3), pages 365-391, September.
- Engel, Charles M., 1984. "Testing for the absence of expected real profits from forward market speculation," Journal of International Economics, Elsevier, vol. 17(3-4), pages 299-308, November.
- Hansen, Lars Peter & Hodrick, Robert J, 1980. "Forward Exchange Rates as Optimal Predictors of Future Spot Rates: An Econometric Analysis," Journal of Political Economy, University of Chicago Press, vol. 88(5), pages 829-53, October.
- Anne Sibert, 1987.
"The risk premium in the foreign exchange market,"
Research Working Paper
87-07, Federal Reserve Bank of Kansas City.
- Kemp, Murray C. & Sinn, Hans-Werner, 2000.
"A simple model of privately profitable but socially useless speculation,"
Munich Reprints in Economics
19475, University of Munich, Department of Economics.
- Murray C. Kemp & Hans-Werner Sinn, 2000. "A Simple Model of Privately Profitable But Socially Useless Speculation," The Japanese Economic Review, Japanese Economic Association, vol. 51(1), pages 84-94, 03.
- Lewis, Karen K., 1995. "Puzzles in international financial markets," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 37, pages 1913-1971 Elsevier.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Lisa Schiff).
If references are entirely missing, you can add them using this form.