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The Forward Market in Emerging Currencies: Less Biased Than in Major Currencies

  • Frankel, Jeffrey

    (Harvard University)

  • Poonawala, Jumana

    (Harvard University)

Many studies have replicated the finding that the forward rate is a biased predictor of the future change in the spot exchange rate. Usually the forward discount actually points in the wrong direction. But, at least until recently, those studies applied only to advanced economies and major currencies. We apply the same tests to a sample of 14 emerging market currencies. We find a smaller bias than for advanced country currencies. The coefficient is on average positive, i.e., the forward discount at least points in the right direction. It is never significantly less than zero. To us this suggests that a time-varying exchange risk premium may not be the explanation for traditional findings of bias. The reasoning is that emerging markets are probably riskier; yet we find that the bias in their forward rates is smaller. Emerging market currencies probably have more easily-identified trends of depreciation than currencies of advanced countries.

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Paper provided by Harvard University, John F. Kennedy School of Government in its series Working Paper Series with number rwp09-023.

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Date of creation: Jul 2009
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Handle: RePEc:ecl:harjfk:rwp09-023
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  1. Charles Engel, 1995. "The Forward Discount Anomaly and the Risk Premium: A Survey of Recent Evidence," NBER Working Papers 5312, National Bureau of Economic Research, Inc.
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  4. Huisman, Ronald & Koedijk, Kees & Kool, Clemens & Nissen, Francois, 1998. "Extreme support for uncovered interest parity," Journal of International Money and Finance, Elsevier, vol. 17(1), pages 211-228, February.
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  10. Hansen, Lars Peter & Hodrick, Robert J, 1980. "Forward Exchange Rates as Optimal Predictors of Future Spot Rates: An Econometric Analysis," Journal of Political Economy, University of Chicago Press, vol. 88(5), pages 829-53, October.
  11. Kenneth A. Froot & Jeffrey A. Frankel, 1989. "Forward Discount Bias: Is it an Exchange Risk Premium?," The Quarterly Journal of Economics, Oxford University Press, vol. 104(1), pages 139-161.
  12. Nikolay Gospodinov, 2006. "A New Look at the Forward Premium Puzzle," Working Papers 08009, Concordia University, Department of Economics, revised Dec 2008.
  13. Breuer, Janice Boucher, 2000. "Term Effects and the Time-Varying Risk Premium in Tests of Forward Foreign Exchange Rate Unbiasedness," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 5(3), pages 211-20, July.
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  19. Bansal, Ravi & Dahlquist, Magnus, 1999. "The Forward Premium Puzzle: Different Tales from Developed and Emerging Economies," CEPR Discussion Papers 2169, C.E.P.R. Discussion Papers.
  20. Jeffrey A. Frankel, 1993. "On Exchange Rates," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061546, June.
  21. Menzie Chinn and Jeffrey Frankel., 1993. "Patterns in Exchange Rate Forecasts for 25 Currencies," Center for International and Development Economics Research (CIDER) Working Papers C93-009, University of California at Berkeley.
  22. Ralph W. Tryon, 1979. "Testing for rational expectations in foreign exchange markets," International Finance Discussion Papers 139, Board of Governors of the Federal Reserve System (U.S.).
  23. Campbell, Rachel & Koedijk, Kees & Lothian, James R & Mahieu, Ronald J, 2007. "Irving Fisher, Expectational Errors, and the UIP Puzzle," CEPR Discussion Papers 6294, C.E.P.R. Discussion Papers.
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  26. Stephen Gilmore & Fumio Hayashi, 2011. "Emerging Market Currency Excess Returns," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(4), pages 85-111, October.
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