Random Walk Expectations and the Forward Discount Puzzle
Two well-known, but seemingly contradictory, features of exchange rates are that they are close to a random walk while at the same time exchange rate changes are predictable by interest rate di erentials. In this paper we investigate whether these two features of the data may in fact be related. In particular, we ask whether the predictability of exchange rates by interest di erentials naturally results when participants in the FX market adopt random walk expectations. We nd that random walk expectations can explain the forward premium puzzle, but only if FX portfolio positions are revised infrequently. In contrast, with frequent portfolio adjustment and random walk expectations, we nd that high interest rate currencies depreciate much more than what UIP would predict.
|Date of creation:||Jan 2007|
|Date of revision:|
|Contact details of provider:|| Postal: |
Phone: ++41 (0)31 780 31 31
Fax: ++41 (0)31 780 31 00
Web page: http://www.szgerzensee.ch/
|Order Information:|| Postal: Studienzentrum Gerzensee, Postfach 21, 3115 Gerzensee|
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Burnside, Craig & Eichenbaum, Martin & Kleshchelski, Isaac & Rebelo, Sérgio, 2006.
"The Returns to Currency Speculation,"
CEPR Discussion Papers
5883, C.E.P.R. Discussion Papers.
- Craig Burnside & Martin Eichenbaum & Isaac Kleshchelski & Sergio Rebelo, 2006. "The Returns to Currency Speculation," 2006 Meeting Papers 864, Society for Economic Dynamics.
- Craig Burnside & Martin Eichenbaum & Isaac Kleshchelski & Sergio Rebelo, 2006. "The Returns to Currency Speculation," NBER Working Papers 12489, National Bureau of Economic Research, Inc.
- Philippe Bacchetta & Eric van Wincoop, 2005.
"Incomplete Information Processing: A Solution to the Forward Discount Puzzle,"
05.03, Swiss National Bank, Study Center Gerzensee.
- Philippe Bacchetta & Eric van Wincoop, 2006. "Incomplete information processing: a solution to the forward discount puzzle," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
- Philippe Bacchetta & Eric van Wincoop, 2006. "Incomplete information processing: a solution to the forward discount puzzle," Working Paper Series 2006-35, Federal Reserve Bank of San Francisco.
- Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
- Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November.
When requesting a correction, please mention this item's handle: RePEc:szg:worpap:0701. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (library)
If references are entirely missing, you can add them using this form.