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The Forward Premium Puzzle and Latent Factors Day by Day

  • Kerstin Bernoth
  • Juergen von Hagen
  • Casper de Vries

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.

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Paper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 246.

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Date of creation: Apr 2010
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Handle: RePEc:dnb:dnbwpp:246
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  16. Polakoff, Michael A. & Grier, Paul C., 1991. "A comparison of foreign exchange forward and futures prices," Journal of Banking & Finance, Elsevier, vol. 15(6), pages 1057-1080, December.
  17. Menzie D. Chinn & Guy Meredith, 2004. "Monetary Policy and Long-Horizon Uncovered Interest Parity," IMF Staff Papers, Palgrave Macmillan, vol. 51(3), pages 409-430, November.
  18. Nick Roussanov & Adrien Verdelhan & Hanno Lustig, 2008. "Common Risk Factors in Currency Markets," 2008 Meeting Papers 711, Society for Economic Dynamics.
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