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Econometrics of the forward premium puzzle

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Author Info

  • Stephen E. Haynes

    ()

  • Avik Chakraborty

    (Department of Economics, University of Tennessee)

Abstract

This paper explores from a new perspective the forward premium puzzle, i.e., why a regression of the change in the future spot exchange rate on the forward premium paradoxically yields a coefficient that is frequently negative. This traditional specification is compared theoretically and empirically to a "level" regression of the future spot rate on the current forward rate, which does not display the puzzle. We explore both non-rationality and risk premium explanations. The general conclusion is that, with non-rationality, any modest deviation from unity in the level coefficient becomes greatly magnified in the forward premium coefficient because of the stationary/nonstationary properties of the relevant variables, thereby generating the puzzle.

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File URL: http://economics.uoregon.edu/papers/UO-2005-18_Haynes_Forward.pdf
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Bibliographic Info

Paper provided by University of Oregon Economics Department in its series University of Oregon Economics Department Working Papers with number 2005-18.

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Length: 23
Date of creation: 15 Oct 2005
Date of revision:
Handle: RePEc:ore:uoecwp:2005-18

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Postal: 1285 University of Oregon, 435 PLC, Eugene, OR 97403-1285
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Web page: http://economics.uoregon.edu/
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Related research

Keywords: Forward premium puzzle; Spot and forward exchange rates; Foreign exchange market efficiency; Non-rationality in foreign exchange markets;

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Cited by:
  1. Georges Prat & Remzi Uctum, 2014. "Expectation formation in the foreign exchange market: a time-varying heterogeneity approach using survey data," Working Papers 2014-235, Department of Research, Ipag Business School.
  2. Pippenger, John E, 2009. "The Forward-Bias Puzzle: A Solution Based on Covered Interest Parity," University of California at Santa Barbara, Economics Working Paper Series qt05d0t24b, Department of Economics, UC Santa Barbara.
  3. 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.
  4. Rohit Vishal Kumar & Dhekra Azouzi, 2011. "Tunisian and Indian Forex Markets: A Comparision on Forward Rate Unbiased Hypothesis," Romanian Economic Journal, Department of International Business and Economics from the Academy of Economic Studies Bucharest, vol. 14(40), pages 81-98, June.
  5. Pippenger, John E, 2010. "The Solution to the Forward-Bias and Related Puzzles," University of California at Santa Barbara, Economics Working Paper Series qt6br3599r, Department of Economics, UC Santa Barbara.
  6. Pippenger, John, 2009. "The Forward-Bias Puzzle: A Solution Based on Covered Interest Parity," University of California at Santa Barbara, Economics Working Paper Series qt4dd1075r, Department of Economics, UC Santa Barbara.
  7. Dhekra Azouzi & Rohit Vishal Kumar & Chaker Aloui, 2011. "Forward Rate Unbiasedness Hypothesis in the Tunisian Exchange Rate Market," International Journal of Academic Research in Business and Social Sciences, Human Resource Management Academic Research Society, International Journal of Academic Research in Business and Social Sciences, vol. 1(2), pages 17-44, July.
  8. Pippenger, John, 2011. "A Complete Solution To The Forward-Bias Puzzle," University of California at Santa Barbara, Economics Working Paper Series qt5gq9z4j0, Department of Economics, UC Santa Barbara.

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