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The forward rate premium puzzle: a case of misspecification?

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  • Hall Stephen G.

    () (Economics Dept, University of Leicester, Leicester, LE1 7RH, UK)

  • Kenjegaliev Amangeldi

    (Dept of Economics, Strathclyde University, Glasgow, G1 1XQ, UK)

  • Swamy P. A. V. B.

    (Federal Reserve Board (retired): c/o, Bank of Greece, 21 E. Venizelos Avenue, GR 102 50 Athens)

  • Tavlas George S.

    (Bank of Greece, 21 E. Venizelos Avenue, GR 102 50 Athens)

Abstract

Empirical studies often report a negative relationship between the difference in the spot exchange rate and the forward premium, violating the forward-rate unbiasedness hypothesis. Using standard regression on a sample of ten exchange rates, we obtain both positive and negative coefficients. We argue that the negative coefficients could arise as a result of the non-linearities in the relationship and misspecification. As an alternative to the standard regression, we use a time-varying-coefficient technique that estimates bias-free coefficients and, thus, should provide better estimates of the link between spot and forward rates. Our findings strongly support the forward rate unbiasedness hypothesis. All the parameters are very close to unity and significant.

Suggested Citation

  • Hall Stephen G. & Kenjegaliev Amangeldi & Swamy P. A. V. B. & Tavlas George S., 2013. "The forward rate premium puzzle: a case of misspecification?," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 17(3), pages 265-279, May.
  • Handle: RePEc:bpj:sndecm:v:17:y:2013:i:3:p:265-279:n:7
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    References listed on IDEAS

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    1. Sakoulis, Georgios & Zivot, Eric & Choi, Kyongwook, 2010. "Structural change in the forward discount: Implications for the forward rate unbiasedness hypothesis," Journal of Empirical Finance, Elsevier, vol. 17(5), pages 957-966, December.
    2. Hausman, Jerry A, 1975. "An Instrumental Variable Approach to Full Information Estimators for Linear and Certain Nonlinear Econometric Models," Econometrica, Econometric Society, vol. 43(4), pages 727-738, July.
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    Cited by:

    1. Tsung-Wu Ho & Wan-Shin Mo, 2016. "Testing the Persistence of the Forward Premium: Structural Changes or Misspecification?," Open Economies Review, Springer, vol. 27(1), pages 119-138, February.
    2. repec:spr:jecfin:v:41:y:2017:i:3:d:10.1007_s12197-016-9363-9 is not listed on IDEAS
    3. Hall, Stephen G. & Hondroyiannis, George & Kenjegaliev, Amangeldi & Swamy, P.A.V.B. & Tavlas, George S., 2013. "Is the relationship between prices and exchange rates homogeneous?," Journal of International Money and Finance, Elsevier, vol. 37(C), pages 411-438.

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