Monetary policy regimes and the forward bias for foreign exchange

Rafaela Perez, Jesus Ruiz and Juan Angel Lafuente

DEE - Working Papers. Business Economics. WB from Universidad Carlos III de Madrid. Departamento de Economía de la Empresa

Abstract: This paper provides a theoretical discussion of the forward premium anomaly. We reformulate the well-known Lucas (1982) model by allowing for the existence of monetary policy regimes. The monetary supply is viewed as having two stochastic components: a) a persistent component that reflects the preferences of the central bank regarding the long-run money supply or inflation target, and b) a transitory component that represents short-lived interventions. To generate agents forecasts, we consider two scenarios: a) consumers can distinguish the permanent and the transitory components of the money supply, and b) consumers can observe only historical series of the aggregate monetary supply and face a signal-extraction problem. We simulate the model from a carefully estimation for the parameters involved in the model. Numerical simulations reveal that, under complete information, forward unbiasedness cannot be rejected at conventionally significant levels. However, when learning about monetary policy is incorporated, the forward bias can be reproduced without artificially assuming an unreasonable degree of risk aversion.

Keywords: Forward; bias; Monetary; policy; Regime; shifts; Learning (search for similar items in EconPapers)
JEL-codes: C22 F31 F47 (search for similar items in EconPapers)
Date: 2012-01
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Journal Article: Monetary policy regimes and the forward bias for foreign exchange (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:cte:wbrepe:12960

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