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Less of a puzzle: a new look at the forward forex market

  • Maurice J. Roche

    ()

    (Department of Economics, National University of Ireland, Maynooth, Ireland)

  • Michael J. Moore

    ()

    (School of Management and Economics, The Queen's University of Belfast, Belfast, Northern Ireland)

The two-country monetary model is extended to include a consumption externality with habit persistence. This is set within a limited participation framework. The model is simulated using the artificial economy methodology. The 'puzzles' in the forward market are re-examined. The model is able to account for (a) the low volatility of the forward discount (b) the higher volatility of expected forward speculative profits (c) the even higher volatility of spot rate changes (d) the persistence in the forward discount and (e) the random walk in spot exchange rates The major innovation is that it is able to replicate some of the extent of the bias of the forward discount as a predictor of realised spot rate changes.

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Paper provided by Department of Economics, Finance and Accounting, National University of Ireland - Maynooth in its series Economics, Finance and Accounting Department Working Paper Series with number n910799.

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Length: 34 pages
Date of creation: Jul 1999
Date of revision:
Handle: RePEc:may:mayecw:n910799
Contact details of provider: Postal: Maynooth, Co. Kildare
Phone: 353-1-7083728
Fax: 353-1-7083934
Web page: http://www.maynoothuniversity.ie/economics-finance-and-accounting

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  1. David K. Backus & Allan W. Gregory & Chris I. Telmer, 1992. "Accounting for Forward Rates in Markets for Foreign Currency," Working Papers 92-18b, New York University, Leonard N. Stern School of Business, Department of Economics.
  2. Philippe Weil, 1989. "The Equity Premium Puzzle and the Riskfree Rate Puzzle," NBER Working Papers 2829, National Bureau of Economic Research, Inc.
  3. Andrew B. Abel, 1990. "Asset Prices under Habit Formation and Catching up with the Joneses," NBER Working Papers 3279, National Bureau of Economic Research, Inc.
  4. 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.
  5. Maurice Obstfeld & Kenneth Rogoff, 1998. "Risk and Exchange Rates," NBER Working Papers 6694, National Bureau of Economic Research, Inc.
  6. Moore, Michael J, 1992. "Covered Purchasing Power Parity, Ex-Ante PPP and Risk Aversion," CEPR Discussion Papers 635, C.E.P.R. Discussion Papers.
  7. Fukuda, Shin-ichi & Hoshi, Takeo & Ito, Takatoshi & Rose, Andrew, 2006. "International Finance," Journal of the Japanese and International Economies, Elsevier, vol. 20(4), pages 455-458, December.
  8. Engel, Charles, 1992. "On the foreign exchange risk premium in a general equilibrium model," Journal of International Economics, Elsevier, vol. 32(3-4), pages 305-319, May.
  9. Charles Engel, 1995. "The Forward Discount Anomaly and the Risk Premium: A Survey of Recent Evidence," NBER Working Papers 5312, National Bureau of Economic Research, Inc.
  10. David K. Backus & Silverio Foresi & Chris I. Telmer, 1995. "Interpreting the Forward Premium Anomaly," Canadian Journal of Economics, Canadian Economics Association, vol. 28(s1), pages 108-119, November.
  11. Flood, Robert P & Rose, Andrew K, 1999. "Understanding Exchange Rate Volatility without the Contrivance of Macroeconomics," Economic Journal, Royal Economic Society, vol. 109(459), pages F660-72, November.
  12. Charles Engel, 1999. "On the Foreign Exchange Risk Premium in Sticky-Price General Equilibrium Models," International Tax and Public Finance, Springer, vol. 6(4), pages 491-505, November.
  13. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November.
  14. Harald Uhlig & Lars Ljungqvist, 2000. "Tax Policy and Aggregate Demand Management under Catching Up with the Joneses," American Economic Review, American Economic Association, vol. 90(3), pages 356-366, June.
  15. John Y. Campbell & John H. Cochrane, 1994. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," CRSP working papers 412, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  16. David K. Backus, 2001. "Affine Term Structure Models and the Forward Premium Anomaly," Journal of Finance, American Finance Association, vol. 56(1), pages 279-304, 02.
  17. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
  18. Moore, Michael J. & Roche, Maurice J., 2001. "Liquidity in the forward exchange market," Journal of Empirical Finance, Elsevier, vol. 8(2), pages 157-170, May.
  19. Geert Bekaert, 1994. "The Time Variation of Risk and Return in Foreign Exchange Markets: A General Equilibrium Perspective," NBER Working Papers 4818, National Bureau of Economic Research, Inc.
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