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The Solution to the Forward-Bias and Related Puzzles

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  • Pippenger, John E

Abstract

The forward-bias puzzle is probably the most important puzzle in international finance. But there is a simple solution. Covered interest parity implies that the forward-bias puzzle is the result of two omitted variables: (1) the future change in the forward exchange rate and (2) the future interest rate differential. As Table 3 shows, at least for my data, the downward bias produced by those two omitted variables completely explains the forward-bias puzzle. Covered interest parity also solves three related puzzles.

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  • 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.
    • Handle: RePEc:cdl:ucsbec:qt6br3599r
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