The Term Structure of Forward Exchange Premia and the Forecastability of Spot Exchange Rates: Correcting the Errors

Richard Clarida and Mark Taylor

No 773, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper challenges the widespread view that forward exchange premia contain little information regarding subsequent spot rate movements. Using weekly dollar/Deutschmark and dollar/sterling data, we show that spot and forward exchange rates are well represented by a vector error correction model and that the vector of forward premia form a basis for the cointegrating space. Dynamic forecasts indicate that the information in the forward premia can be used to reduce the root mean squared forecast error for the spot rate (relative to a random walk forecast) by at least 33% at a six-month horizon and by between 50% and 90% at a one-year horizon.

Keywords: Cointegration; Efficiency; Forecasting; Forward Exchange Rate; Information; Spot Exchange Rate (search for similar items in EconPapers)
JEL-codes: F31 F47 (search for similar items in EconPapers)
Date: 1993-06
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Citations: View citations in EconPapers (15)

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Working Paper: The Term Structure of Forward Exchange Premia and the Forecastibility of Spot Exchange Rates: Correcting the Errors (1993)
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