The forward rate premium puzzle: a case of misspecification?

Hall, Stephen G.; Kenjegaliev, Amangeldi; Swamy, P. A. V. B.; Tavlas, George S.

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.

Citation

Hall, S. G., Kenjegaliev, A., Swamy, P. A. V. B., & Tavlas, G. S. (2013). The forward rate premium puzzle: a case of misspecification?. Studies in nonlinear dynamics and econometrics / sponsored by the MIT Press and the Society for Nonlinear Dynamics and Econometrics, 17(3), 265-279. https://doi.org/10.1515/snde-2013-0009

• Journal Article Type: Article
• Acceptance Date: Apr 1, 2013
• Publication Date: Jan 1, 2013
• Print ISSN: 1081-1826
• Publisher: De Gruyter
• Peer Reviewed: Peer Reviewed
• Volume: 17
• Issue: 3
• Pages: 265-279
• DOI: https://doi.org/10.1515/snde-2013-0009
• Keywords: Economics and Econometrics; Social Sciences (miscellaneous); Analysis
• Public URL: https://hull-repository.worktribe.com/output/429268