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

Author Info

  • 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. 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.
  2. 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 F660-72, November.
  3. Michael J Moore; & Maurice Roche, 1995. "Liquidity in the Forward Exchange Market," Economics, Finance and Accounting Department Working Paper Series n580795, Department of Economics, Finance and Accounting, National University of Ireland - Maynooth.
  4. 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.
  5. Charles Engel, 1999. "On the Foreign-Exchange Risk Premium in Sticky-Price General Equilibrium Models," NBER Working Papers 7067, National Bureau of Economic Research, Inc.
  6. Maurice Obstfeld & Kenneth Rogoff, 1998. "Risk and Exchange Rates," NBER Working Papers 6694, National Bureau of Economic Research, Inc.
  7. 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.
  8. Abel, A.B., 1990. "Asset Prices Under Habit Formation And Catching Up With The Joneses," Weiss Center Working Papers 1-90, Wharton School - Weiss Center for International Financial Research.
  9. David K. Backus & Allan W. Gregory & Chris I. Telmer, 1990. "Accounting for Forward Rates in Markets for Foreign Currency," Working Papers 792, Queen's University, Department of Economics.
  10. 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.
  11. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
  12. 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.
  13. 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.
  14. 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.
  15. 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 427-70.
  16. David Backus & Silverio Foresi & Chris Telmer, . "Interpreting the Forward Premium Anomoly," GSIA Working Papers 15, Carnegie Mellon University, Tepper School of Business.
  17. 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.
  18. 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.
  19. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November.
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