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Possible solutions to the forward bias paradox

  • Richard T., Baillie
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    This note outlines the economic theory behind the theory of uncovered interest parity and some of the econometric issues involved in testing and interpretation. I illustrate some of the issues involved by estimating a rolling regression of the forward premium regression from 22 years of eight major currencies. I also conclude that Pippenger's model is not consistent with the theory of UIP and that furthermore there are severe econometric problems in estimating his model. The forward premium anomaly remains a paradox in international finance that is important and worthwhile to understand more fully.

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    File URL: http://www.sciencedirect.com/science/article/pii/S1042443111000345
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    Article provided by Elsevier in its journal Journal of International Financial Markets, Institutions and Money.

    Volume (Year): 21 (2011)
    Issue (Month): 4 (October)
    Pages: 617-622

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    Handle: RePEc:eee:intfin:v:21:y:2011:i:4:p:617-622
    Contact details of provider: Web page: http://www.elsevier.com/locate/intfin

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    2. Richard T. Baillie & Rehim Kilic, 2005. "Do Asymmetric and Nonlinear Adjustments Explain the Forward Premium Anomaly?," Working Papers 543, Queen Mary University of London, School of Economics and Finance.
    3. Lothian, James R. & Wu, Liuren, 2011. "Uncovered interest-rate parity over the past two centuries," Journal of International Money and Finance, Elsevier, vol. 30(3), pages 448-473, April.
    4. Baillie, Richard T. & Bollerslev, Tim, 2000. "The forward premium anomaly is not as bad as you think," Journal of International Money and Finance, Elsevier, vol. 19(4), pages 471-488, August.
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    8. 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.
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    12. Zhou, Su, 2002. "The forward premium anomaly and the trend behavior of the exchange rates," Economics Letters, Elsevier, vol. 76(2), pages 273-279, July.
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    15. Flood, Robert P & Rose, Andrew K, 1996. "Fixes: Of the Forward Discount Puzzle," The Review of Economics and Statistics, MIT Press, vol. 78(4), pages 748-52, November.
    16. Alex Maynard & Peter C. B. Phillips, 2001. "Rethinking an old empirical puzzle: econometric evidence on the forward discount anomaly," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 16(6), pages 671-708.
    17. Lars Peter Hansen & Robert J. Hodrick, 1983. "Risk Averse Speculation in the Forward Foreign Exchange Market: An Econometric Analysis of Linear Models," NBER Chapters, in: Exchange Rates and International Macroeconomics, pages 113-152 National Bureau of Economic Research, Inc.
    18. Baillie, Richard T. & Chang, Sanders S., 2011. "Carry trades, momentum trading and the forward premium anomaly," Journal of Financial Markets, Elsevier, vol. 14(3), pages 441-464, August.
    19. Cornell, Bradford, 1977. "Spot rates, forward rates and exchange market efficiency," Journal of Financial Economics, Elsevier, vol. 5(1), pages 55-65, August.
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