A New Look at the Forward Premium Puzzle
AbstractThis paper analyzes the sampling properties of the widely documented large negative slope estimates in regressions of future exchange returns on current forward premium. We argue that the abnormal behavior of the slope estimators in these regressions arises from the simultaneous presence of high persistence, low signal-to-noise ratio, strong endogeneity and an omitted variable problem. The paper develops the limiting theory for the slope parameter estimators in the levels and differenced forward premium regressions under some assumptions that match the empirical properties of the data. The asymptotic results derived in the paper help to reconcile the findings from the levels and difference specifications and provide important insights about the time series properties of the implied risk premium.
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Bibliographic InfoPaper provided by Concordia University, Department of Economics in its series Working Papers with number 08009.
Length: 36 pages
Date of creation: Sep 2006
Date of revision: Dec 2008
Forward premium anomaly; high persistence; low signal-to-noise ratio; local-to-unity asymptotics;
Other versions of this item:
- C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
- C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models
- F31 - International Economics - - International Finance - - - Foreign Exchange
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- Jeffrey Frankel & Jumana Poonawala, 2006.
"The Forward Market in Emerging Currencies: Less Biased Than in Major Currencies,"
NBER Working Papers
12496, National Bureau of Economic Research, Inc.
- Frankel, Jeffrey & Poonawala, Jumana, 2010. "The forward market in emerging currencies: Less biased than in major currencies," Journal of International Money and Finance, Elsevier, vol. 29(3), pages 585-598, April.
- Frankel, Jeffrey A. & Poonawala, Jumana, 2009. "The Forward Market in Emerging Currencies: Less Biased than in Major Currencies," Scholarly Articles 4448888, Harvard Kennedy School of Government.
- Frankel, Jeffrey & Poonawala, Jumana, 2009. "The Forward Market in Emerging Currencies: Less Biased Than in Major Currencies," Working Paper Series rwp09-023, Harvard University, John F. Kennedy School of Government.
- Bai, Shuming & Mollick, Andre Varella, 2010. "Currency crisis and the forward discount bias: Evidence from emerging economies under breaks," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 20(5), pages 556-574, December.
- Shang, Hua, 2013. "Inference in asset pricing models with a low-variance factor," Journal of Banking & Finance, Elsevier, vol. 37(3), pages 1046-1060.
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