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Forward Discount Bias: Is it Near‐Rationality in the Foreign Exchange Market?

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  • DAVID W. R. GRUEN
  • GORDON D. MENZIES

Abstract

A risk‐averse US investor adjusts the shares of a portfolio of short‐term nominal domestic and foreign assets to maximize expected utility. The optimal strategy is to respond immediately to all new information which arrives weekly. We develop a model to estimate the cost of optimizing less frequently and find that it is generally very small. For example, if the investor adjusts portfolio shares every three months, an average expected utility loss of 0.16 per cent p.a. is incurred. Hence, slight opportunity costs of frequent optimization may outweigh the benefits. This result may help explain forward discount bias.

Suggested Citation

  • David W. R. Gruen & Gordon D. Menzies, 1995. "Forward Discount Bias: Is it Near‐Rationality in the Foreign Exchange Market?," The Economic Record, The Economic Society of Australia, vol. 71(2), pages 157-166, June.
    • Handle: RePEc:bla:ecorec:v:71:y:1995:i:2:p:157-166
    DOI: 10.1111/j.1475-4932.1995.tb01882.x
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