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The Bias For Forward Exchange Rate And The Risk Premium: An Explanation With A Stochastic And Dynamic General Equilibrium Model

Author

Listed:
  • Juan A. Lafuente

    () (Universitat Jaume I)

  • Jesús Ruiz

    (Universidad Complutense de Madrid)

Abstract

Forward exchange rate unbiassedness is rejected in test for international exchange markets. Such issue can be interpreted as evidence of a biased forward rate and/or time-varying risk premia. This paper proposes a stochastic general equilibrium model which generates substantial variability in the magnitude of predictable excess returns. Simulation exercises suggest that higher persistency in the monetary policy produces higher bias in the estimated slope coefficient in the regression of the change in the logarithm of the spot exchange rate on the forward premium. Also, our model suggest that the nature of the transmission between monetary shocks can explain the excess returns puzzle. Empirical evidence for the DM-USD rate that support our theoretical results is provided. La insesgadez del tipo forward ha sido ampliamente rechazada en los estudios empíricos sobre los mercados de tipo cambio internacionales. Este aspecto puede interpretarse como la existencia de un sesgo en la capacidad predictiva del tipo forward y/o la presencia de una prima de riesgo cambiante en el tiempo. Este trabajo propone un modelo dinámico y estocástico de equilibrio general que genera amplia volatilidad en la prima de riesgo. Los ejercicios de simulación llevados a cabo sugieren que una mayor persistencia de la política monetaria produce un mayor sesgo en la pendiente estimada de una regresión del cambio en el logaritmo del tipo spot sobre la prima de riesgo. Además, el modelo sugiere que la naturaleza de la transmisión de los shocks monetarios puede explicar dicho sesgo. Finalmente, el trabajo presenta evidencia empírica sobre el tipo de cambio entre el marco alemán y el dólar americano en línea con los resultados teóricos.

Suggested Citation

  • Juan A. Lafuente & Jesús Ruiz, 2002. "The Bias For Forward Exchange Rate And The Risk Premium: An Explanation With A Stochastic And Dynamic General Equilibrium Model," Working Papers. Serie EC 2002-20, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
  • Handle: RePEc:ivi:wpasec:2002-20
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    References listed on IDEAS

    as
    1. Bekaert, Geert & Hodrick, Robert J., 1993. "On biases in the measurement of foreign exchange risk premiums," Journal of International Money and Finance, Elsevier, vol. 12(2), pages 115-138, April.
    2. Kim, Soyoung & Roubini, Nouriel, 2000. "Exchange rate anomalies in the industrial countries: A solution with a structural VAR approach," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 561-586, June.
    3. Bilson, John F O, 1981. "The "Speculative Efficiency" Hypothesis," The Journal of Business, University of Chicago Press, vol. 54(3), pages 435-451, July.
    4. Bekaert, Geert, 1994. "Exchange rate volatility and deviations from unbiasedness in a cash-in-advance model," Journal of International Economics, Elsevier, vol. 36(1-2), pages 29-52, February.
    5. Engel, Charles, 1996. "The forward discount anomaly and the risk premium: A survey of recent evidence," Journal of Empirical Finance, Elsevier, vol. 3(2), pages 123-192, June.
    6. Hodrick, Robert J., 1989. "Risk, uncertainty, and exchange rates," Journal of Monetary Economics, Elsevier, vol. 23(3), pages 433-459, May.
    7. Tauchen, George, 2001. "The bias of tests for a risk premium in forward exchange rates," Journal of Empirical Finance, Elsevier, vol. 8(5), pages 695-704, December.
    8. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 335-359.
    9. Baillie, Richard T. & Bollerslev, Tim, 2000. "The forward premium anomaly is not as bad as you think," Journal of International Money and Finance, Elsevier, vol. 19(4), pages 471-488, August.
    10. Canova, Fabio & Marrinan, Jane, 1993. "Profits, risk, and uncertainty in foreign exchange markets," Journal of Monetary Economics, Elsevier, vol. 32(2), pages 259-286, November.
    11. Tiff Macklem, R., 1991. "Forward exchange rates and risk premiums in artificial economies," Journal of International Money and Finance, Elsevier, vol. 10(3), pages 365-391, September.
    12. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November.
    13. Dutton, John, 1993. "Real and Monetary Shocks and Risk Premia in Forward Markets for Foreign Exchange," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 25(4), pages 731-754, November.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Teoría de las expectativas; Prima de riesgo; Tipo de cambio forward; Simulación. Expectations theory; Risk premium; Forward exchange rates; Simulations.;

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications

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