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Less of a puzzle: a new look at the forward forex market

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Listed author(s):
  • Moore, Michael J.
  • Roche, Maurice J.

Abstract

The two-country monetary model is extended to include a consumption externality with habit persistence. This is set within a limited participation framework. The model is simulated using the artificial economy methodology. The 'puzzles' in the forward market are re-examined. The model is able to account for (a) the low volatility of the forward discount (b) the higher volatility of expected forward speculative profits (c) the even higher volatility of spot rate changes (d) the persistence in the forward discount and (e) the random walk in spot exchange rates The major innovation is that it is able to replicate some of the extent of the bias of the forward discount as a predictor of realised spot rate changes.

(This abstract was borrowed from another version of this item.)

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Article provided by Elsevier in its journal Journal of International Economics.

Volume (Year): 58 (2002)
Issue (Month): 2 (December)
Pages: 387-411

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Handle: RePEc:eee:inecon:v:58:y:2002:i:2:p:387-411
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505552

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Find related papers by JEL classification:
  • F31 - International Economics - - International Finance - - - Foreign Exchange
  • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
  • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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  1. Abel, Andrew B, 1990. "Asset Prices under Habit Formation and Catching Up with the Joneses," American Economic Review, American Economic Association, vol. 80(2), pages 38-42, May.
  2. David K. Backus, 2001. "Affine Term Structure Models and the Forward Premium Anomaly," Journal of Finance, American Finance Association, vol. 56(1), pages 279-304, 02.
  3. David K. Backus & Silverio Foresi & Chris I. Telmer, 1995. "Interpreting the Forward Premium Anomaly," Canadian Journal of Economics, Canadian Economics Association, vol. 28(s1), pages 108-119, November.
  4. Michael J. Moore, 1997. "Covered Purchasing Power Parity, Ex-ante PPP and Risk Aversion," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 24(3), pages 397-412.
  5. Maurice Obstfeld & Kenneth Rogoff, 1998. "Risk and Exchange Rates," NBER Working Papers 6694, National Bureau of Economic Research, Inc.
  6. Flood, Robert P & Rose, Andrew K, 1999. "Understanding Exchange Rate Volatility without the Contrivance of Macroeconomics," Economic Journal, Royal Economic Society, vol. 109(459), pages 660-672, November.
  7. Weil, Philippe, 1989. "The equity premium puzzle and the risk-free rate puzzle," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 401-421, November.
  8. Engel, Charles, 1996. "The forward discount anomaly and the risk premium: A survey of recent evidence," Journal of Empirical Finance, Elsevier, vol. 3(2), pages 123-192, June.
  9. Backus, David K & Gregory, Allan W & Telmer, Chris I, 1993. " Accounting for Forward Rates in Markets for Foreign Currency," Journal of Finance, American Finance Association, vol. 48(5), pages 1887-1908, December.
  10. John Y. Campbell & John H. Cochrane, 1994. "By force of habit: a consumption-based explanation of aggregate stock market behavior," Working Papers 94-17, Federal Reserve Bank of Philadelphia.
  11. Moore, Michael J. & Roche, Maurice J., 2001. "Liquidity in the forward exchange market," Journal of Empirical Finance, Elsevier, vol. 8(2), pages 157-170, May.
  12. Engel, Charles, 1992. "On the foreign exchange risk premium in a general equilibrium model," Journal of International Economics, Elsevier, vol. 32(3-4), pages 305-319, May.
  13. John C. Cox & Jonathan E. Ingersoll Jr. & Stephen A. Ross, 2005. "A Theory Of The Term Structure Of Interest Rates," World Scientific Book Chapters,in: Theory Of Valuation, chapter 5, pages 129-164 World Scientific Publishing Co. Pte. Ltd..
  14. Charles Engel, 1999. "On the Foreign Exchange Risk Premium in Sticky-Price General Equilibrium Models," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 6(4), pages 491-505, November.
  15. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 335-359.
  16. Bekaert, Geert, 1996. "The Time Variation of Risk and Return in Foreign Exchange Markets: A General Equilibrium Perspective," Review of Financial Studies, Society for Financial Studies, vol. 9(2), pages 427-470.
  17. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November.
  18. Harald Uhlig & Lars Ljungqvist, 2000. "Tax Policy and Aggregate Demand Management under Catching Up with the Joneses," American Economic Review, American Economic Association, vol. 90(3), pages 356-366, June.
  19. Fukuda, Shin-ichi & Hoshi, Takeo & Ito, Takatoshi & Rose, Andrew, 2006. "International Finance," Journal of the Japanese and International Economies, Elsevier, vol. 20(4), pages 455-458, December.
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