The Forex Forward Puzzle: The Career Risk Hypothesis

Fang Liu and Piet Sercu

The Financial Review, 2009, vol. 44, issue 3, 371-404

Abstract: We conjecture that the forward puzzle may reflect career risks. When professional investors observe public danger signals about a currency, they require a premium for holding it. We find evidence of this in Exchange Rate Mechanism rates. As deep discounts do signal danger, we next specify nonlinear variants of the Fama regression to capture this risk. We also decompose the forward premium into a long‐memory trend and short‐term component. We find empirical evidence for a career risk premium; risk is in fact dominant in the trend component while the short‐term component loads more on expectations. All confidence intervals are calculated via Monte Carlo.

Date: 2009
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