The Term Structure of Forward Exchange Premia and the Forecastibility of Spot Exchange Rates: Correcting the Errors
AbstractWe present theory and evidence that challenges the view that forward premia contain little information regarding subsequent spot rate movements. Using weekly dollar-mark and dollar sterling data, we find that spot and forward exchange rates together are well represented by a vector error correction model; that there exists exactly the number of cointegrating relationships predicted by a simple theoretical framework and that a basis for this cointegrating space is the vector of forward premia. Dynamic forecasts indicate that the information in the forward premia can be used to reduce the root mean squared forecast error for the spot rate (relative to a random walk forecast) by at least 33 percent at a 6-month horizon and by some 50 to 90 percent at a 1year horizon.
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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4442.
Date of creation: Aug 1993
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Publication status: published as Review of Economics and Statistics, LXXIX (August 1997).
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Other versions of this item:
- Clarida, Richard & Taylor, Mark P, 1993. "The Term Structure of Forward Exchange Premia and the Forecastability of Spot Exchange Rates: Correcting the Errors," CEPR Discussion Papers 773, C.E.P.R. Discussion Papers.
- F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
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