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

Author

Listed:
  • 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.

Suggested Citation

  • 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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    References listed on IDEAS

    as
    1. Frankel, Jeffrey A & Froot, Kenneth A, 1987. "Using Survey Data to Test Standard Propositions Regarding Exchange Rate Expectations," American Economic Review, American Economic Association, vol. 77(1), pages 133-153, March.
    2. Furukawa, Chishio, 2019. "Publication Bias under Aggregation Frictions: Theory, Evidence, and a New Correction Method," EconStor Preprints 194798, ZBW - Leibniz Information Centre for Economics.
    3. McCallum, Bennett T., 1994. "A reconsideration of the uncovered interest parity relationship," Journal of Monetary Economics, Elsevier, vol. 33(1), pages 105-132, February.
    4. Theo S. Eicher & Chris Papageorgiou & Adrian E. Raftery, 2011. "Default priors and predictive performance in Bayesian model averaging, with application to growth determinants," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 26(1), pages 30-55, January/F.
    5. Backus, David K & Gregory, Allan W & Telmer, Chris I, 1993. " Accounting for Forward Rates in Markets for Foreign Currency," Journal of Finance, American Finance Association, vol. 48(5), pages 1887-1908, December.
    6. Bekaert, Geert, 1995. "The Time Variation of Expected Returns and Volatility in Foreign-Exchange Markets," Journal of Business & Economic Statistics, American Statistical Association, vol. 13(4), pages 397-408, October.
    7. Yu, Jianfeng, 2013. "A sentiment-based explanation of the forward premium puzzle," Journal of Monetary Economics, Elsevier, vol. 60(4), pages 474-491.
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    More about this item

    Keywords

    Forward rate bias; uncovered interest parity; meta-analysis; publication bias; model uncertainty;

    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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