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Econometrics of the Forward Premium Puzzle

Author

Listed:
  • Avik Chakraborty

    (University of Tennessee, Knoxville)

  • Stephen E. Haynes

    (University of Oregon)

Abstract

This paper compares the "level" regression of the future spot rate on the current forward rate, which yields a slope coefficient close to unity, to the forward premium puzzle, i.e., a regression of the change in the spot exchange rate on the forward premium, which paradoxically yields a slope coefficient that is frequently negative. We argue that the striking difference between these two otherwise equivalent regressions follows from the existence of a bias together with the non-stationarity of underlying variables. In addition, we contend that non-rationality may potentially explain the existence of the bias that generates the forward premium puzzle.

Suggested Citation

  • Avik Chakraborty & Stephen E. Haynes, 2008. "Econometrics of the Forward Premium Puzzle," Economics Bulletin, AccessEcon, vol. 6(42), pages 1-17.
    • Handle: RePEc:ebl:ecbull:eb-08f00006
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    File URL: http://www.accessecon.com/pubs/EB/2008/Volume6/EB-08F00006A.pdf
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    Citations

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    Cited by:

    1. Georges Prat & Remzi Uctum, 2015. "Expectation formation in the foreign exchange market: a time-varying heterogeneity approach using survey data," Applied Economics, Taylor & Francis Journals, vol. 47(34-35), pages 3673-3695, July.
    2. Georges Prat & Remzi Uctum, 2014. "Expectation formation in the foreign exchange market: a time-varying heterogeneity approach using survey data," Working Papers hal-04141348, HAL.
    3. Pippenger, John, 2009. "The Forward-Bias Puzzle: A Solution Based on Covered Interest Parity," University of California at Santa Barbara, Economics Working Paper Series qt4dd1075r, Department of Economics, UC Santa Barbara.
    4. Pippenger, John E, 2010. "The Solution to the Forward-Bias and Related Puzzles," University of California at Santa Barbara, Economics Working Paper Series qt6br3599r, Department of Economics, UC Santa Barbara.
    5. Brian Lucey & Grace Loring, 2012. "Forward Exchange Rate Biasedness across Developed and Developing Country Currencies - Do Observed Patterns Persist Out of Sample?Abstract:," The Institute for International Integration Studies Discussion Paper Series iiisdp404, IIIS.
    6. Pippenger, John, 2011. "A Complete Solution To The Forward-Bias Puzzle," University of California at Santa Barbara, Economics Working Paper Series qt5gq9z4j0, Department of Economics, UC Santa Barbara.
    7. Pippenger, John E, 2009. "The Forward-Bias Puzzle: A Solution Based on Covered Interest Parity," University of California at Santa Barbara, Economics Working Paper Series qt05d0t24b, Department of Economics, UC Santa Barbara.
    8. Pippenger, John, 2011. "The solution to the forward-bias puzzle," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 21(2), pages 296-304, April.
    9. Kumar, Satish & Trück, Stefan, 2014. "Unbiasedness and risk premiums in the Indian currency futures market," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 29(C), pages 13-32.
    10. Loring, Grace & Lucey, Brian, 2013. "An analysis of forward exchange rate biasedness across developed and developing country currencies: Do observed patterns persist out of sample?," Emerging Markets Review, Elsevier, vol. 17(C), pages 14-28.

    More about this item

    Keywords

    Forward premium puzzle;

    JEL classification:

    • F0 - International Economics - - General
    • F3 - International Economics - - International Finance

    Statistics

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