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The forward rate premium puzzle: a case of misspecification?1)

Author

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  • Hall Stephen G.

    (Economics Dept, University of Leicester, Leicester, LE1 7RH, UK)

  • Kenjegaliev Amangeldi

    (Dept of Economics, Strathclyde University, Glasgow, G1 1XQ, UK)

  • Swamy P. A. V. B.

    (Federal Reserve Board (retired): c/o, Bank of Greece, 21 E. Venizelos Avenue, GR 102 50 Athens)

  • Tavlas George S.

    (Bank of Greece, 21 E. Venizelos Avenue, GR 102 50 Athens)

Abstract

Empirical studies often report a negative relationship between the difference in the spot exchange rate and the forward premium, violating the forward-rate unbiasedness hypothesis. Using standard regression on a sample of ten exchange rates, we obtain both positive and negative coefficients. We argue that the negative coefficients could arise as a result of the non-linearities in the relationship and misspecification. As an alternative to the standard regression, we use a time-varying-coefficient technique that estimates bias-free coefficients and, thus, should provide better estimates of the link between spot and forward rates. Our findings strongly support the forward rate unbiasedness hypothesis. All the parameters are very close to unity and significant.

Suggested Citation

  • Hall Stephen G. & Kenjegaliev Amangeldi & Swamy P. A. V. B. & Tavlas George S., 2013. "The forward rate premium puzzle: a case of misspecification?1)," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 17(3), pages 265-279, May.
    • Handle: RePEc:bpj:sndecm:v:17:y:2013:i:3:p:265-279:n:7
    DOI: 10.1515/snde-2013-0009
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    References listed on IDEAS

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    Cited by:

    1. Zigraiova, Diana & Havranek, Tomas & Irsova, Zuzana & Novak, Jiri, 2021. "How puzzling is the forward premium puzzle? A meta-analysis," European Economic Review, Elsevier, vol. 134(C).
    2. Stephen G. Hall & Heather D. Gibson & G. S. Tavlas & Mike G. Tsionas, 2020. "A Monte Carlo Study of Time Varying Coefficient (TVC) Estimation," Computational Economics, Springer;Society for Computational Economics, vol. 56(1), pages 115-130, June.
    3. Hall, Stephen G. & Hondroyiannis, George & Kenjegaliev, Amangeldi & Swamy, P.A.V.B. & Tavlas, George S., 2013. "Is the relationship between prices and exchange rates homogeneous?," Journal of International Money and Finance, Elsevier, vol. 37(C), pages 411-438.
    4. Amit K. Sinha & Philip A. Horvath & Robert C. Scott, 2017. "The real miss-specification in the forward rate premium puzzle," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 41(3), pages 463-473, July.

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    More about this item

    Keywords

    forward premium anomaly; time-varying-coefficient; spurious relationship; JEL classifications: C51; E43;
    All these keywords.

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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