Time-Varying forward Bias and the Volatility of Risk Premium: a Monetary Explanation

Juan Angel Lafuente and Jesus Ruiz

Documentos de Trabajo del ICAE from Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico

Abstract: Forward exchange rate unbiassedness is rejected for international exchange markets. This paper proposes a stochastic general equilibrium model which generates substantial variability in the magnitude of predictable excess returns. Simulation exercises suggest that high persistency in the monetary policy produces greater bias in the estimated slope coefficient in the regression of the change in the logarithm of the spot exchange rate on the forward premium. Also, our model suggest that the nature of the transmission between monetary shocks can explain the excess return puzzle. Empirical evidence for the US-UK exchange rate according to our theoretical results is provided.

Pages: pages 32
Date: 2002
New Economics Papers: this item is included in nep-cmp, nep-ifn and nep-mfd
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