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Understanding the Forward Premium Puzzle: A Microstructure Approach

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  • Burnside, Craig
  • Eichenbaum, Martin
  • Rebelo, Sérgio

Abstract

High-interest-rate currencies tend to appreciate relative to low-interest-rate currencies. We argue that adverse-selection problems between participants in foreign exchange markets can account for this `forward premium puzzle.' The key feature of our model is that the adverse selection problem facing market makers is worse when, based on public information, a currency is expected to appreciate.

Suggested Citation

  • Burnside, Craig & Eichenbaum, Martin & Rebelo, Sérgio, 2007. "Understanding the Forward Premium Puzzle: A Microstructure Approach," CEPR Discussion Papers 6399, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:6399
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    References listed on IDEAS

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    More about this item

    Keywords

    Exchange rates; microstructure; Uncovered interest parity;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange

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