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New Evidence on the Forward Premium Puzzle

Published online by Cambridge University Press:  13 July 2016

Jacob Boudoukh ,
Matthew Richardson  and
Robert F. Whitelaw
Jacob Boudoukh
Affiliation:
[email protected], Arison School of Business, Interdisciplinary Center, Herzlia 46150, Israel
Matthew Richardson
Affiliation:
[email protected], New York University, Stern School of Business, New York, NY 10012, and National Bureau of Economic Research
Robert F. Whitelaw*
Affiliation:
[email protected], New York University, Stern School of Business, New York, NY 10012, and National Bureau of Economic Research.
*
*Corresponding author: [email protected]
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Abstract

The forward premium anomaly (exchange rate changes are negatively related to interest rate differentials) is one of the most robust puzzles in financial economics. We recast the underlying parity relation in terms of lagged forward interest rate differentials, documenting a reversal of the anomalous sign on the coefficient in the traditional specification. We show that this novel evidence is consistent with recent empirical models of exchange rates that imply exchange rate changes depend on two key variables: the interest rate differential and the magnitude of the deviation of the current exchange rate from that implied by purchasing power parity.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 51 , Issue 3 , June 2016 , pp. 875 - 897
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2016 

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