Speculative trading and its effect on the forward premium puzzle: new evidence from Japanese yen market

The aim of the paper is to investigate a forward premium anomaly in reference to the speculation strategy carry trade. The article focuses on the Japanese yen. The paper shows that the existence of the puzzle is highly dependent on the frequency of crisis episodes, the sign and size of the interest rate differential, and the attractiveness of the currency as a target or funding one in carry trade. The study shows that the uncovered interest parity holds during a high-volatility period and the forward premium anomaly arises in a low-volatility regime. However, the anomaly does not appear for all tested exchange rates. For currency pairs with a high interest-rate differential, it seems to apply to the exchange rates where a high-yielding currency is perceived as an attractive target currency. In turn, for currency pairs with slightly different interest rates, it depends highly on the sign of interest rate differential and the currency’s attractiveness as a funding currency.