The Forward Rate Premium Puzzle: A Resolution?

Stephen Hall, P. A. V. B. Swamy (), George Tavlas and Amangeldi Kenjegaliev ()

No 11/23, Discussion Papers in Economics from Division of Economics, School of Business, University of Leicester

Abstract: Empirical studies report that there is a negative relationship between the spot difference and forward premium. This result violates the forward rate unbiasedness theory. Using standard regression we found that recent samples give mixed results with both positive and negative coefficients. One possibility is that the negative coefficients could arise due to the non-linearities in the series and misspecification. To overcome these problems we employed a relatively novel technique. As an alternative to the standard regression we used a time-varying coefficient technique. This methodology estimates bias-free coefficients and thus should provide better estimates of the link between spot and forward rates. The findings of the time-varying coefficient model strongly support the forward rate unbiasedness hypothesis. All the parameters are very close to unity and significant. At the same time our results do not violate the efficient market theory.

Keywords: Forward premium anomaly; Time-varying coefficients; spurious (search for similar items in EconPapers)
JEL-codes: C51 E43 (search for similar items in EconPapers)
Date: 2011-03
New Economics Papers: this item is included in nep-fmk
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Citations: View citations in EconPapers (6)

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