Nonlinearity in Deviations from Uncovered Interest Parity: An Explanation of the Forward Bias Puzzle

Lucio Sarno, Giorgio Valente () and Hyginus Leon

No 5527, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We provide empirical evidence that deviations from the uncovered interest rate parity (UIP) condition display significant nonlinearities, consistent with theories based on transactions costs or limits to speculation. This evidence suggests that the forward bias documented in the literature may be less indicative of major market inefficiencies than previously thought. Monte Carlo experiments allow us to reconcile these results with the large empirical literature on the forward bias puzzle since we show that, if the true process of UIP deviations were of the nonlinear form we consider, estimation of conventional spot-forward regressions would generate the anomalies documented in previous research.

Keywords: Foreign exchange; Uncovered interest parity; Forward bias; Nonlinearity (search for similar items in EconPapers)
JEL-codes: F31 (search for similar items in EconPapers)
Date: 2006-03
New Economics Papers: this item is included in nep-cba, nep-fmk and nep-ifn
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (123)

Downloads: (external link)
https://cepr.org/publications/DP5527 (application/pdf)

Related works:
Journal Article: Nonlinearity in Deviations from Uncovered Interest Parity: An Explanation of the Forward Bias Puzzle (2006)
Working Paper: Nonlinearity in Deviations From Uncovered Interest Parity: An Explanation of the Forward Bias Puzzle (2006)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:5527

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP5527

Access Statistics for this paper

More papers in CEPR Discussion Papers from Centre for Economic Policy Research 33 Great Sutton Street, London EC1V 0DX, UK.
Bibliographic data for series maintained by CEPR ().