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How Puzzling Is the Forward Premium Puzzle? A Meta-Analysis

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  • Diana Zigraiova

    (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Opletalova 26, 110 00, Prague, Czech Republic
    European Stability Mechanism, Luxembourg)

  • Tomas Havranek

    (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Opletalova 26, 110 00, Prague, Czech Republic)

  • Jiri Novak

    (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Opletalova 26, 110 00, Prague, Czech Republic)

Abstract

A key theoretical prediction in financial economics is that under risk neutrality and rational expectations a currency´s forward rates should form unbiased predictors of future spot rates. Yet scores of empirical studies report negative slope coefficients from regressions of spot rates on forward rates, which is inconsistent with the forward rate unbiasedness hypothesis. We collect 3,643 estimates from 91 research articles and using recently developed techniques investigate the effect of publication and misspecification biases on the reported results. Correcting for these biases we estimate the slope coefficients of 0.31 and 0.98 for developed and emerging currencies respectively, which implies that empirical evidence is in line with the theoretical prediction for emerging economies and less puzzling than commonly thought for developed economies. Our results also suggest that the coefficients are systematically influenced by the choice of data, numeraire currencies, and estimation methods.

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  • Diana Zigraiova & Tomas Havranek & Jiri Novak, 2020. "How Puzzling Is the Forward Premium Puzzle? A Meta-Analysis," Working Papers IES 2020/6, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised Feb 2020.
  • Handle: RePEc:fau:wpaper:wp2020_06
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    More about this item

    Keywords

    Forward rate bias; uncovered interest parity; meta-analysis; publication bias; model uncertainty;
    All these keywords.

    JEL classification:

    • C83 - Mathematical and Quantitative Methods - - Data Collection and Data Estimation Methodology; Computer Programs - - - Survey Methods; Sampling Methods
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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