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Home Bias in Currency Forecasts

  • Yu-chin Chen

    (University of Washington and Hong Kong Institute for Monetary Research)

  • Kwok Ping Tsang

    (Virginia Tech and Hong Kong Institute for Monetary Research)

  • Wen Jen Tsay

    (Academia Sinica)

The "home bias" phenomenon states that empirically, economic agents often under-utilize opportunities beyond their country borders, and it is well-documented in various international pricing and purchase patterns. This bias manifests in the forms of fewer exchanges of goods and net equity-holdings, as well as less arbitrage of price differences across borders than theoretically predicted to be optimal. Our paper documents another form of home bias, where market participants appear to under-weigh information beyond their borders when making currency forecasts. Using monthly data from 1995 to 2010 for seven major exchange rates relative to the US dollar, we show that excess currency returns and the errors in investors' consensus forecasts not only depend on the interest differentials between the pair of countries, but they depend more strongly on interest rates in a broader set of countries. A global short interest differential and a global long interest differential are driving the results.

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Paper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 272010.

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Length: 37 pages
Date of creation: Oct 2010
Date of revision:
Handle: RePEc:hkm:wpaper:272010
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  1. Yu-chin Chen & Kwok Ping Tsang, 2011. "A Macro-Finance Approach to Exchange Rate Determination," Working Papers 012011, Hong Kong Institute for Monetary Research.
  2. Hanno Lustig & Adrien Verdelhan, 2007. "The Cross Section of Foreign Currency Risk Premia and Consumption Growth Risk," American Economic Review, American Economic Association, vol. 97(1), pages 89-117, March.
  3. Yu-chin Chen & Kwok Ping Tsang, 2010. "What Does the Yield Curve Tell Us about Exchange Rate Predictability?," Working Papers 292010, Hong Kong Institute for Monetary Research.
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