Working Paper
The forward exchange rate bias: a new explanation
Abstract: Although the literature has devoted prodigious resources to investigating the risk premium explanation of the systematic time-varying discrepancies between forward and corresponding future spot exchange rates, empirical verification of the risk premium hypothesis has proven elusive. This paper tests an alternative explanation of the forward bias: the anticipated real exchange rate hypothesis. This hypothesis states that except for a constant risk premium, the predictable, time varying wedge between forward and expected future spot exchange rates is fully explained by the anticipated rate of change in the real exchange rate. The data do not reject this hypothesis. This suggests that the literature's almost singular concern with the risk premium explanation of the forward bias should be amended to include the effects of anticipated real exchange rate movements.
Keywords: Foreign exchange futures;
Access Documents
File(s): File format is text/html http://www.federalreserve.gov/pubs/ifdp/1988/338/default.htm
File(s): File format is application/pdf http://www.federalreserve.gov/pubs/ifdp/1988/338/ifdp338.pdf
Authors
Bibliographic Information
Provider: Board of Governors of the Federal Reserve System (U.S.)
Part of Series: International Finance Discussion Papers
Publication Date: 1988
Number: 338