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Resolving the unbiasedness and forward premium puzzles

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  • Daniel L. Thornton

Abstract

There are two unresolved puzzles in the empirical foreign exchange literature. The first is the finding that tests of forward rate unbiasedness using the forward rate and forward premium equations yield markedly different conclusions. A companion puzzle - the forward premium puzzle - is the fact that the forward premium incorrectly predicts the direction of the subsequent change in the spot rate, which implies a massive rejection of uncovered interest parity. This paper resolves both puzzles.

Suggested Citation

  • Daniel L. Thornton, 2007. "Resolving the unbiasedness and forward premium puzzles," Working Papers 2007-014, Federal Reserve Bank of St. Louis.
    • Handle: RePEc:fip:fedlwp:2007-014
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    Cited by:

    1. Wajid Shakeel Ahmed & Shoaib Khattak & Ijlal Ahmed, 2023. "Do forward premium rates predict the spot rates? Comparison of developed and emerging economies," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 28(2), pages 2178-2187, April.
    2. Kerstin Bernoth & Jürgen von Hagen & Casper G. de Vries, 2018. "Estimating a Latent Risk Premium in Exchange Rate Futures," Discussion Papers of DIW Berlin 1733, DIW Berlin, German Institute for Economic Research.
    3. Erdemlioglu, Deniz M, 2007. "A new Test of Uncovered Interest Rate Parity: Evidence from Turkey," MPRA Paper 10787, University Library of Munich, Germany.
    4. Brian Lucey & Grace Loring, 2012. "Forward Exchange Rate Biasedness across Developed and Developing Country Currencies - Do Observed Patterns Persist Out of Sample?Abstract:," The Institute for International Integration Studies Discussion Paper Series iiisdp404, IIIS.
    5. Dąbrowski, Marek A. & Janus, Jakub, 2021. "Does the interest parity puzzle hold for Central and Eastern European economies?," MPRA Paper 107558, University Library of Munich, Germany.
    6. Joscha Beckmann & Robert L. Czudaj & Gary Koop, 2019. "An empirical assessment of recent challenges in today's financial markets," Scottish Journal of Political Economy, Scottish Economic Society, vol. 66(1), pages 1-4, February.
    7. Loring, Grace & Lucey, Brian, 2013. "An analysis of forward exchange rate biasedness across developed and developing country currencies: Do observed patterns persist out of sample?," Emerging Markets Review, Elsevier, vol. 17(C), pages 14-28.
    8. Kerstin Bernoth & Jürgen von Hagen & Casper G. de Vries, 2020. "Currency Futures' Risk Premia and Risk Factors," Discussion Papers of DIW Berlin 1866, DIW Berlin, German Institute for Economic Research.

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