An analysis of forward exchange rate biasedness across developed and developing country currencies: Do observed patterns persist out of sample?

Abstract

Forward exchange rate unbiasedness hypothesis (FRUH) has been a widely researched subject for decades. Recently, the sample populations of these studies have expanded to include developing country currencies. The majority of these findings have been that forward rate biasedness is more pronounced for developed country currencies than it is for developing country currencies. One such paper (Frankel and Poonawala, 2010) has further suggested that this phenomenon may contradict Risk Premium Theory since developing country currencies are relatively more volatile. Our analysis first replicates the results of Frankel and Poonawala and then extends the study out of sample using an updated composition of currency classifications. The results of this extended period of analysis show that forward rate biasedness is less pronounced for developed country currencies than for developing country currencies and consequently does not establish grounds to challenge Risk Premium Theory. Furthermore, our results are consistent with another branch of literature which suggests that conflicting FRUH test results may be particular to the time period examined. It is therefore possible to speculate that period-specific factors were responsible for the results found in previous research.