Why is the forward exchange rate forecast biased? A survey of recent evidence
AbstractForward exchange rate unbiasedness is rejected in tests from the current floating exchange rate era. This paper surveys advances in this area since the publication of Hodrick's (1987) survey. It documents that the change in the future exchange rate is generally negatively related to the forward premium. Properties of the expected forward forecast error are reviewed. Issues such as the relation of uncovered interest parity to real interest parity, and the implications of uncovered interest parity for cointegration of various quantities are discussed. The modeling and testing for risk premiums is surveyed. Included in this area are tests of the consumption CAPM, tests of the latent variable model, and portfolio-balance models of risk premiums. General equilibrium models of the risk premium are examined and their empirical implications explored. The survey does not cover the important areas of learning and peso problems, tests of rational expectations based on survey data, or the models of irrational expectations and speculative bubbles.
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Bibliographic InfoPaper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number 95-06.
Date of creation: 1995
Date of revision:
Other versions of this item:
- Engel, C., 1995. "Why is the Foreward Exchange Rate Forecast Based? A Survey of Recent Evidence," Working Papers 95-08, University of Washington, Department of Economics.
- Engel, C., 1995. "Why is the Foreward Exchange Rate Forecast Based? A Survey of Recent Evidence," Discussion Papers in Economics at the University of Washington 95-08, Department of Economics at the University of Washington.
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