Econometrics of the forward premium puzzle
Loading...
Date
2005-09-15
Authors
Chakraborty, Avik, 1975-
Haynes, Stephen E., 1945-
Journal Title
Journal ISSN
Volume Title
Publisher
University of Oregon, Dept of Economics
Abstract
This paper explores from a new perspective the forward premium puzzle, i.e., why a regression of the change in the future spot exchange rate on the forward premium paradoxically yields a coefficient that is frequently negative. This traditional specification is compared theoretically and empirically to a "level" regression of the future spot rate on the current forward rate, which does not display the puzzle. We explore both non-rationality and risk premium explanations. The general conclusionis that, with non-rationality, any modest deviation from unity in the level coefficient becomes greatly magnified in the forward premium coefficient because of the stationary/nonstationary properties of the relevant variables, thereby generating the puzzle.
Description
23 p.
Keywords
Forward premium puzzle, Spot and forward exchange rates, Foreign exchange market efficiency, Non-rationality in foreign exchange markets