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Resolving the unbiasedness and forward premium puzzles

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  • Daniel L. Thornton

Abstract

There are two unresolved puzzles in the empirical foreign exchange literature. The first is the finding that tests of forward rate unbiasedness using the forward rate and forward premium equations yield markedly different conclusions. A companion puzzle - the forward premium puzzle - is the fact that the forward premium incorrectly predicts the direction of the subsequent change in the spot rate, which implies a massive rejection of uncovered interest parity. This paper resolves both puzzles.

Suggested Citation

  • Daniel L. Thornton, 2007. "Resolving the unbiasedness and forward premium puzzles," Working Papers 2007-014, Federal Reserve Bank of St. Louis.
  • Handle: RePEc:fip:fedlwp:2007-014
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    File URL: http://research.stlouisfed.org/wp/2007/2007-014.pdf
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    Cited by:

    1. Erdemlioglu, Deniz M, 2007. "A new Test of Uncovered Interest Rate Parity: Evidence from Turkey," MPRA Paper 10787, University Library of Munich, Germany.
    2. Loring, Grace & Lucey, Brian, 2013. "An analysis of forward exchange rate biasedness across developed and developing country currencies: Do observed patterns persist out of sample?," Emerging Markets Review, Elsevier, vol. 17(C), pages 14-28.

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    Keywords

    Foreign exchange;

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