Advanced Search
MyIDEAS: Login to save this paper or follow this series

The Forward-Bias Puzzle: A Solution Based on Covered Interest Parity

Contents:

Author Info

  • Pippenger, John E
Registered author(s):

    Abstract

    The forward-bias puzzle is probably the most important puzzle in international macroeconomics. After more than 20 years, there is no accepted solution. My solution is based on covered interest parity (CIP). CIP implies: (1) Forward rates are not rational expectations of future spot rates. Those expectations depend on future spot rates and interest rate differentials. (2) The forward bias is the result of a specification error, replacing future forward exchange rates with current forward exchange rates. That misspecification is the direct result of (1). Implication (1) has the further implication that, in general, covered and uncovered interest parity are inconsistent.

    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.escholarship.org/uc/item/05d0t24b.pdf;origin=repeccitec
    Download Restriction: no

    Bibliographic Info

    Paper provided by Department of Economics, UC Santa Barbara in its series University of California at Santa Barbara, Economics Working Paper Series with number qt05d0t24b.

    as in new window
    Length:
    Date of creation: 01 Mar 2009
    Date of revision:
    Handle: RePEc:cdl:ucsbec:qt05d0t24b

    Contact details of provider:
    Postal: 2127 North Hall, Santa Barbara, CA 93106-9210
    Phone: (805) 893-3670
    Fax: (805) 893-8830
    Web page: http://www.escholarship.org/repec/ucsbecon_dwp/
    More information through EDIRC

    Related research

    Keywords: forward bias; covered interest parity; arbitrage;

    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. Akram, Q. Farooq & Rime, Dagfinn & Sarno, Lucio, 2006. "Arbitrage in the Foreign Exchange Market: Turning on the Microscope," SIFR Research Report Series 42, Institute for Financial Research.
    2. Mark E. Wohar & Nathan S. Balke, 1998. "Nonlinear dynamics and covered interest rate parity," Empirical Economics, Springer, vol. 23(4), pages 535-559.
    3. Leon, Hyginus & Sarno, Lucio & Valente, Giorgio, 2006. "Nonlinearity in Deviations from Uncovered Interest Parity: An Explanation of the Forward Bias Puzzle," CEPR Discussion Papers 5527, C.E.P.R. Discussion Papers.
    4. repec:ebl:ecbull:v:6:y:2008:i:42:p:1-17 is not listed on IDEAS
    5. Avik Chakraborty & Stephen E. Haynes, 2008. "Econometrics of the Forward Premium Puzzle," Economics Bulletin, AccessEcon, vol. 6(42), pages 1-17.
    6. Jonathan Kearns, 2007. "Commodity Currencies: Why Are Exchange Rate Futures Biased if Commodity Futures Are Not?," The Economic Record, The Economic Society of Australia, vol. 83(260), pages 60-73, 03.
    7. Goodhart, Charles A E & McMahon, Patrick C & Ngama, Yerima Lawan, 1992. "Does the Forward Premium/Discount Help to Predict the Future Change in the Exchange Rate?," Scottish Journal of Political Economy, Scottish Economic Society, vol. 39(2), pages 129-40, May.
    8. Maurice Obstfeld & Kenneth Rogoff, 2001. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," NBER Chapters, in: NBER Macroeconomics Annual 2000, Volume 15, pages 339-412 National Bureau of Economic Research, Inc.
    9. Geert Bekaert & Min Wei & Yuhang Xing, 2002. "Uncovered Interest Rate Parity and the Term Structure," NBER Working Papers 8795, National Bureau of Economic Research, Inc.
    10. Stephen E. Haynes & Avik Chakraborty, 2005. "Econometrics of the forward premium puzzle," University of Oregon Economics Department Working Papers 2005-18, University of Oregon Economics Department.
    11. George W. Evans & Avik Chakraborty, 2006. "Can Perpetual Learning Explain the Forward Premium Puzzle?," University of Oregon Economics Department Working Papers 2006-8, University of Oregon Economics Department, revised 20 Aug 2006.
    12. Lucio Sarno, 2005. "Towards a Solution to the Puzzles in Exchange Rate Economics: Where Do We Stand?," Working Papers wp05-11, Warwick Business School, Finance Group.
    13. Lucio Sarno, 2005. "Viewpoint: Towards a solution to the puzzles in exchange rate economics: where do we stand?," Canadian Journal of Economics, Canadian Economics Association, vol. 38(3), pages 673-708, August.
    14. Sercu, Piet & Vinaimont, Tom, 2006. "The forward bias in the ECU: Peso risks vs. fads and fashions," Journal of Banking & Finance, Elsevier, vol. 30(8), pages 2409-2432, August.
    15. Giorgio Valente & H. L. Leon & Lucio Sarno, 2006. "Nonlinearity in Deviations From Uncovered Interest Parity," IMF Working Papers 06/136, International Monetary Fund.
    Full references (including those not matched with items on IDEAS)

    Citations

    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:cdl:ucsbec:qt05d0t24b. 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: (Lisa Schiff).

    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.