Time-varying forward bias and the expected excess return

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This study, motivated by the parameter instability in the forward premium regression, proposes and estimates a time-varying forward bias model of three exchange rates, the dollar–DM, dollar–yen and dollar–pound rates, using the Kalman filter technique. A measure of the expected excess return is constructed. The properties of forward bias and the expected excess returns are investigated. We also examine the possible determinants of the time-varying forward bias and the expected excess return by testing four variants of the Lucas [J. Monetary Econ. 10 (1982) 335] model.