The Forward Exchange Rate Bias Puzzle: Evidence from New Cointegration Tests

Raj Aggarwal, Brian Lucey and Sunil K. Mohanty

The Institute for International Integration Studies Discussion Paper Series from IIIS

Abstract: An important puzzle in international finance is the failure of the forward exchange rate to be a rational forecast of the future spot rate. It has often been suggested that this puzzle may be resolved by using better statistical procedures that correct for both non-stationarity and nonnormality in the data. We document that even after accounting for non-stationarity, nonnormality, and heteroscedasticity using parametric and non-parametric tests on data for over a quarter century, US dollar forward rates for horizons ranging from one to twelve months for the major currencies, the British pound, Japanese yen, Swiss franc, and the German mark, are generally not rational forecasts of future spot rates. These findings of non-rationality in forward exchange rates for the major currencies continue to be puzzling especially as these foreign exchange markets are some of the most liquid asset markets with very low trading costs.

Keywords: flight-to-quality; contagion; multivariate GARCH (search for similar items in EconPapers)
JEL-codes: F31 F47 G14 G15 (search for similar items in EconPapers)
Date: 2006-04-05
New Economics Papers: this item is included in nep-cba, nep-ets, nep-fin, nep-fmk, nep-for, nep-ifn and nep-mon
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Citations: View citations in EconPapers (1)

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