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The Forward Premium Puzzle and Latent Factors Day by Day

Author

Listed:
  • Kerstin Bernoth
  • Jürgen von Hagen
  • Casper G. de Vries

Abstract

We use futures instead of forward rates to study the complete maturity spectrum of the forward premium puzzle from two days to six months. At short maturities the slope coefficient is positive, but these turn negative as the maturity increases to the monthly level. Futures data allow us to control for the influence of an unobserved factor that can be decomposed into a contract-specific and a time- to-maturity effect. Once we do this, we find that the coefficients on the forward premium are much closer to one. The latent factor is shown to be related to conventional proxies of risk.

Suggested Citation

  • Kerstin Bernoth & Jürgen von Hagen & Casper G. de Vries, 2010. "The Forward Premium Puzzle and Latent Factors Day by Day," Discussion Papers of DIW Berlin 989, DIW Berlin, German Institute for Economic Research.
    • Handle: RePEc:diw:diwwpp:dp989
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    Cited by:

    1. Tamgac, Unay, 2013. "Duration of fixed exchange rate regimes in emerging economies," Journal of International Money and Finance, Elsevier, vol. 37(C), pages 439-467.
    2. Aziz Chouikh & Abdelwahed Trabelsi, 2014. "Modeling Risk Premia in Forward Foreign Exchange Rates as Unobserved Components: The Model Identification Problem," International Journal of Financial Research, International Journal of Financial Research, Sciedu Press, vol. 5(3), pages 119-135, July.
    3. Virginie Coudert & Cyriac Guillaumin & Hélène Raymond, 2014. "Looking at the other side of carry trades: Are there any safe haven currencies?," Working Papers hal-04141355, HAL.

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    Keywords

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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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