The Forward Exchange Rate Bias Puzzle: Evidence from New Cointegration Tests
AbstractAn important puzzle in international finance is the failure of the forward exchange rate to be a rational forecast of the future spot rate. It has often been suggested that this puzzle may be resolved by using better statistical procedures that correct for both non-stationarity and nonnormality in the data. We document that even after accounting for non-stationarity, nonnormality, and heteroscedasticity using parametric and non-parametric tests on data for over a quarter century, US dollar forward rates for horizons ranging from one to twelve months for the major currencies, the British pound, Japanese yen, Swiss franc, and the German mark, are generally not rational forecasts of future spot rates. These findings of non-rationality in forward exchange rates for the major currencies continue to be puzzling especially as these foreign exchange markets are some of the most liquid asset markets with very low trading costs.
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Bibliographic InfoPaper provided by IIIS in its series The Institute for International Integration Studies Discussion Paper Series with number iiisdp123.
Date of creation: 05 Apr 2006
Date of revision:
flight-to-quality; contagion; multivariate GARCH;
Find related papers by JEL classification:
- F31 - International Economics - - International Finance - - - Foreign Exchange
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies
- F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-04-22 (All new papers)
- NEP-CBA-2006-04-22 (Central Banking)
- NEP-ETS-2006-04-22 (Econometric Time Series)
- NEP-FIN-2006-04-22 (Finance)
- NEP-FMK-2006-04-22 (Financial Markets)
- NEP-FOR-2006-04-22 (Forecasting)
- NEP-IFN-2006-04-22 (International Finance)
- NEP-MON-2006-04-22 (Monetary Economics)
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