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Nonlinearity as an explanation of the forward exchange rate anomaly

Author

Listed:
  • D. (Derek) Bond
  • Niall Hession
  • Michael J. Harrison
  • Edward J. (Edward Joseph) O'Brien

Abstract

This paper shows that nonlinearity can provide an explanation for the forward exchange rate anomaly (Fama, 1984). Using sterling-Canadian dollar data, and modelling nonlinearity of unspecified form by means of a random field, we find strong evidence of time-wise nonlinearity and, significantly, obtain parameter estimates that conform with theory to a high degree of precision: the anomaly disappears.

Suggested Citation

  • D. (Derek) Bond & Niall Hession & Michael J. Harrison & Edward J. (Edward Joseph) O'Brien, 2008. "Nonlinearity as an explanation of the forward exchange rate anomaly," Working Papers 200801, School of Economics, University College Dublin.
  • Handle: RePEc:ucn:wpaper:200801
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    File URL: http://hdl.handle.net/10197/1272
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    References listed on IDEAS

    as
    1. Lucio Sarno & Giorgio Valente & Hyginus Leon, 2006. "Nonlinearity in Deviations from Uncovered Interest Parity: An Explanation of the Forward Bias Puzzle," Review of Finance, European Finance Association, vol. 10(3), pages 443-482, September.
    2. Alex Maynard, 2006. "The forward premium anomaly: statistical artefact or economic puzzle? New evidence from robust tests," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 39(4), pages 1244-1281, November.
    3. Hai, Weike & Mark, Nelson C & Wu, Yangru, 1997. "Understanding Spot and Forward Exchange Rate Regressions," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 12(6), pages 715-734, Nov.-Dec..
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    6. 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.
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    8. 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.
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    11. Baillie, Richard T. & Kilic, Rehim, 2006. "Do asymmetric and nonlinear adjustments explain the forward premium anomaly?," Journal of International Money and Finance, Elsevier, vol. 25(1), pages 22-47, February.
    12. Gil-Alana, Luis A., 2002. "Empirical evidence of the spot and the forward exchange rates in Canada," Economics Letters, Elsevier, vol. 77(3), pages 405-409, November.
    13. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November.
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    15. Unknown, 2005. "Forward," 2005 Conference: Slovenia in the EU - Challenges for Agriculture, Food Science and Rural Affairs, November 10-11, 2005, Moravske Toplice, Slovenia 183804, Slovenian Association of Agricultural Economists (DAES).
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    More about this item

    Keywords

    Forward exchange rate anomaly; Nonlinearity; Random field regression; Foreign exchange; Nonlinear theories; Random fields;
    All these keywords.

    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

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