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The Information in Long-Maturity Forward Rates: Implications for Exchange Rates and the Forward Premium Anomaly

Jacob Boudoukh, Matthew Richardson and Robert Whitelaw

No 11840, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: The forward premium anomaly is one of the most robust puzzles in financial economics. We recast the underlying parity relation in terms of cross-country differences between forward interest rates rather than spot interest rates with dramatic results. These forward interest rate differentials have statistically and economically significant forecast power for annual exchange rate movements, both in- and out-of-sample, and the signs and magnitudes of the corresponding coefficients are consistent with economic theory. Forward interest rates also forecast future spot interest rates and future inflation. Thus, we attribute much of the forward premium anomaly to the anomalous behavior of short-term interest rates, not to a breakdown of the link between fundamentals and exchange rates.

JEL-codes: G15 F31 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin, nep-fmk, nep-for and nep-ifn
Date: 2005-12
Note: AP IFM
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