Econometrics of the Forward Premium Puzzle

Avik Chakraborty () and Stephen E. Haynes ()
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Avik Chakraborty: University of Tennessee, Knoxville
Stephen E. Haynes: University of Oregon

Economics Bulletin, 2008, vol. 6, issue 42, 1-17

Abstract: This paper compares the "level" regression of the future spot rate on the current forward rate, which yields a slope coefficient close to unity, to the forward premium puzzle, i.e., a regression of the change in the spot exchange rate on the forward premium, which paradoxically yields a slope coefficient that is frequently negative. We argue that the striking difference between these two otherwise equivalent regressions follows from the existence of a bias together with the non-stationarity of underlying variables. In addition, we contend that non-rationality may potentially explain the existence of the bias that generates the forward premium puzzle.

Keywords: Forward; premium; puzzle (search for similar items in EconPapers)
JEL-codes: F0 F3 (search for similar items in EconPapers)
Date: 2008-10-07
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Citations: View citations in EconPapers (11)

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