Forward Exchange Rates Research Articles

Measuring Financial Barriers Among East African Community Countries

This paper seeks to quantify existing financial barriers among East African Community (EAC) member countries based on analysis of each member country’s foreign exchange market. The primary contribution of this paper is the generation of an aggregate measure of financial barriers for the three relatively more advanced members (Kenya, Uganda, and Tanzania) using forward foreign exchange and interbank interest rate data. Its empirical results, which are corroborated by other evidence such as the levels of development of the financial markets and restrictions on capital flows, suggest that Kenya is the EAC’s most financially open country, followed by Uganda, and then Tanzania. The fact that the three countries exhibit different degrees of financial openness suggests that financial integration in the EAC region has a way to go.

Investor Overconfidence and the Forward Premium Puzzle

We offer an explanation for the forward premium puzzle in foreign exchange markets based upon investor overconfidence. In the model, overconfident individuals overreact to their information about future inflation, which causes greater overshooting in the forward rate than in the spot rate. Thus, when agents observe a signal of higher future inflation, the consequent rise in the forward premium predicts a subsequent downward correction of the spot rate. The model can explain the magnitude of the forward premium bias and several other stylized facts related to the joint behavior of forward and spot exchange rates. Our approach is also consistent with the availability of profitable carry trade strategies.

Measuring Financial Barriers Among East African Community Countries

This paper seeks to quantify existing financial barriers among East African Community (EAC) member countries based on analysis of each member country’s foreign exchange market. The primary contribution of this paper is the generation of an aggregate measure of financial barriers for the three relatively more advanced members (Kenya, Uganda, and Tanzania) using forward foreign exchange and interbank interest rate data. Its empirical results, which are corroborated by other evidence such as the levels of development of the financial markets and restrictions on capital flows, suggest that Kenya is the EAC’s most financially open country, followed by Uganda, and then Tanzania. The fact that the three countries exhibit different degrees of financial openness suggests that financial integration in the EAC region has a way to go.

Investor Overconfidence and the Forward Premium Puzzle

We offer an explanation for the forward premium puzzle in foreign exchange markets based upon investor overconfidence. In the model, overconfident individuals overreact to their information about future inflation, which causes greater overshooting in the forward rate than in the spot rate. Thus, when agents observe a signal of higher future inflation, the consequent rise in the forward premium predicts a subsequent downward correction of the spot rate. The model can explain the magnitude of the forward premium bias and several other stylized facts related to the joint behavior of forward and spot exchange rates. Our approach is also consistent with the availability of profitable carry trade strategies

The Forward Exchange Rate Bias Puzzle Is Persistent: Evidence from Stochastic and Nonparametric Cointegration Tests

AbstractAn important puzzle in international finance is the failure of the forward exchange rate to be a rational forecast of the future spot rate. We document that even after accounting for nonstationarity, nonnormality, and heteroskedasticity using parametric and nonparametric tests on data for over a quarter century, U.S. dollar forward rates for the major currencies (the British pound, Japanese yen, Swiss franc, and the German mark) are generally not rational forecasts of future spot rates. These findings deepen the forward exchange rate bias puzzle, especially as these markets are the most liquid foreign exchange markets with very low trading costs.

Nonlinearity as an explanation of the forward exchange rate anomaly

This article shows that nonlinearity can provide an explanation for the forward exchange rate anomaly (Fama, 1984). Using sterling-Canadian dollar data and modelling nonlinearity of unspecified form by means of a random field, we find strong evidence of time-wise nonlinearity and, significantly, obtain parameter estimates that conform with theory to a high degree of precision.

Forward Exchange Rate Puzzle: Joining the Missing Pieces in the Rand-US Dollar Exchange Market

The Unbiased forward rate hypothesis (UFRH) stipulates that the forward rates should be a perfect predictor for the future spot rates. A number of studies conducted in order to test the UFRH and foreign market efficiency, have come to the conclusion that the hypothesis does not hold. This phenomenon is dubbed as the UFRH puzzle. A number of studies that reject the UFRH have made use of ordinary least square methods and support a linear adjustment between spot and forward exchange rates. This paper establishes that the use of a linear model in testing the UFRH can lead to a misspecification problem if indeed there is a nonlinear adjustment between the forward and spot exchange rates. In order to overcome the problem of model misspecification, this paper applies the nonlinear method of the class of the Smooth Transition Regression (STR) model in assessing the relationship between the rand-US dollar future spot and forward exchange rates. With the aid of a series of diagnostic tests, the paper shows that there is indeed a nonlinear adjustment process between the rand-US dollar spot and forward exchange rates and that there exists a regime in the STR model where the UFRH eventually holds.

FORECASTING FORWARD EXCHANGE RATE RISK PREMIUM IN SINGAPORE DOLLAR/US DOLLAR EXCHANGE RATE MARKET

In this research, monthly forward exchange rates are evaluated for possible existence of time varying risk premia in Singapore forward foreign exchange rates against US dollar. The time varying risk premia in Singapore dollar is modeled using non-Gaussian signal plus noise models that encompass non-normality and time varying volatility.The results from signal plus noise models show statistically significant evidence of time varying risk premium in Singapore forward exchange rates although we failed to reject the hypotheses of no risk premium in the series. The results from Gaussian versions of these models are not much different and are in line with Wolff (1987) who also used the same methodology in Gaussian settings.Our results show statistically significant evidence of volatility clustering in Singapore forward exchange rates. The results from Gaussian signal plus noise models also show statistically significant evidence of volatility clustering and non-normality in Singapore forward foreign exchange rates. Additional tests on the series show that exclusion of conditional heteroskedasticity from the signal plus noise models leads to false statistical inferences.

LEARNING, THE FORWARD PREMIUM PUZZLE, AND MARKET EFFICIENCY

The Forward Premium Puzzle is widely considered to indicate inefficiency in the foreign exchange market. This paper proposes a resolution of the puzzle using recursive least squares learning. Risk-neutral agents learn the unknown parameters, underlying the exchange rate generation process, using constant-gain recursive least squares. Simulations using plausible model parameter values replicate the anomaly along with other observed empirical features of the forward and spot exchange rate data. Estimates of parameter values from data support the model assumptions and justify the use of constant-gain learning. The conclusion is that the puzzle is not necessarily a reflection of inefficiency.

Investigation of quantitative magnetisation transfer parameters of lesions and normal appearing white matter in multiple sclerosis

The aim of this study was to use quantitative magnetisation transfer (MT) imaging to assess the different pathological substrates of tissue damage in multiple sclerosis (MS) and examine whether the MT parameters may be used to explain the disability in relapsing remitting (RR) MS. Thirteen patients with RRMS and 14 healthy controls were prescribed conventional MRI and quantitative MT imaging at 3.0 T. A two-pool model of MT (where A refers to the free pool and B to the macromolecular pool) was fitted to the data yielding a longitudinal relaxation rate R(A), a relative size F of macromolecular pool, transverse relaxation times T(2) (A) and T(2) (B) for the two pools and a forward exchange rate RM(0) (B). The MT ratio (MTR) was also computed. The mean MT parameters of the normal appearing white matter (NAWM) and of lesions in patients, and of white matter in controls were estimated. MT parameters were significantly different between lesions and NAWM in patients, and between the NAWM and the white matter of controls (with the exception of T(2) (B) and the MTR). Two models were investigated using ordered logistic regression, with the expanded disability status scale (EDSS) as the dependent variable. In the first one, mean NAWM MT parameters and lesion load were entered as explanatory variables; in the second one, mean MT variables within lesions and lesion load were entered as explanatory variables. Unexpectedly, T(2) (B) was the parameter most significantly associated with EDSS in NAWM. This parameter might represent a weighted average of the relaxation times of spins with different molecular environments, and therefore its variation could indicate a change in the balance between subpopulations of macromolecular spins. Conversely, in lesions, RM(0) (B), T(2) (B), F, R(A), and lesion load significantly predicted disability only when combined together. This might reflect the complex interaction between demyelination, remyelination, gliosis, inflammation and axonal loss taking place within lesions.

Exchange Rate Risk Premiums in Hong Kong Dollar: A Signal-Extraction Approach

Forward exchange rates convey information about the risk premiums of the currency exposures of the investors. The extraction of these risk premiums provides market information for the expected future values of a currency, which may be useful for policymakers in their market surveillance and monitoring. This study utilises a state-space model and the Kalman-filtering technique to estimate risk premiums of Hong Kong dollar from the forward exchange market from 1996 to 2005. The estimated risk premiums of the 12-motnh forward contract were as high as 3.4% of the spot exchange rate during the Asian financial crisis in 1998. The study also finds that the risk premiums have reverted from a discount in late 2004 to close to zero in mid-2005, reflecting that the appreciation pressure on the Hong Kong dollar along with the speculation on the revaluation of the renminbi in early 2005 has subsided after the introduction of the three refinements to the operation of the Linked Exchange Rate system in May 2005 and the reform of the renminbi exchange rate regime in July 2005. The forward exchange rates, after taking the estimated risk premiums into account, do not have a good forecasting capability for the future spot exchange rates. Among the two financial factors that drive the risk premiums in the Hong Kong dollar forward rates, the renminbi non-deliverable forward rates appear to have a larger impact than the Aggregate Balance of the banking system. Nonetheless, both factors are important for monitoring the risk premiums of the Hong Kong dollar exchange rate.

Volatility dependence across Asia-Pacific onshore and offshore currency forwards markets

This paper estimates switching autoregressive conditional heteroskedasticity (SWARCH) time series models for weekly returns of nine Asian forward exchange rates. We find two regimes with different volatility levels, whereby each regime displays considerable persistence. Our analysis provides evidence that the knock-on effects from China's currency forwards markets upon other Asian countries have been modest, in that little evidence exists for co-dependence of volatility regimes.

Inference on forward exchange rate risk premium: reviewing signal extraction methods

The existence of risk premium is thought to be the reason why forward exchange rate is not an unbiased predictor of future spot exchange rate. In this paper we review two methodologies for inferring this unobserved risk premium based upon signal extraction mechanism. One approach relies on the theory of derivatives pricing that relates historical and risk neutral measures via market price of risk. The other approach specifies the risk premium in the historical measure directly. We compare these two methods in predicting future spot exchange rates and contrast these with that of random walk forecast.

Forecasting of Forward Exchange Rate using Orbital Instability and Long-Term Memory

Forecasting of Forward Exchange Rate using Orbital Instability and Long-Term Memory

Resolving the Unbiasedness Puzzle in the Foreign Exchange Market

An unresolved puzzle in the empirical foreign exchange literature is that tests of forward rate unbiasedness using the forward rate and forward premium equations yield markedly different conclusions about the unbiasedness of the forward exchange rate. This puzzle is resolved by showing that because of the persistence in exchange rates, estimates of the slope coefficient from the forward premium equation are extremely sensitive to small violations of the null hypothesis of the type and magnitude that are likely to exist in the real world. Moreover, contrary to suggestions in the literature and common practice, the forward premium equation does not necessarily provide a better test of unbiasedness than the forward rate equation.

Volatility Dependence Across Asia-Pacific Onshore and Offshore Currency Forwards Markets

This paper estimates switching autoregressive conditional heteroskedasticity (SWARCH) time series models for weekly returns of nine Asian forward exchange rates. We find two regimes with different volatility levels, whereby each regime displays considerable persistence. Our analysis provides evidence that the knock-on effects from China's currency forwards markets upon other Asian countries have been modest, in that little evidence exists for co-dependence of volatility regimes.

The Relative Size of New Zealand Exchange Rate and Interest Rate Responses to News

This paper examines the relative size of the effects of New Zealand monetary policy and macroeconomic data surprises on the spot exchange rate, 2 and 5 year swap rate differentials, and the synthetic forward exchange rate schedule. We find that the spot exchange rate and 5 year swap rates respond by a similar magnitude to monetary surprises, implying there is little response of the forward exchange rate to this type of news. In contrast, the spot exchange rate responds by nearly three times as much as 5 year interest rates to CPI and GDP surprises, implying that forward rates appreciate to higher than expected CPI or GDP news. This is in contrast to standard theoretical models and US evidence. Lastly, we show that exchange rates but not interest rates respond to current account news. The implications of these results for monetary policy are considered.

Are Forward Exchange Rates Rational Forecasts of Future Spot Rates? An Improved Econometric Analysis for the Major Currencies

It has been suggested that prior studies that have puzzlingly found forward rates to be inefficient and biased forecasts of future spot rates may be limited by inadequate statistical methodologies. Using an improved statistical methodology that accounts for both non-stationarity and non-normality in exchange rates, we unfortunately reconfirm that U.S. dollar forward rates for horizons ranging from one to twelve months for the British pound, Japanese yen, Swiss franc, and the German mark over the period 1973–1998 are generally not efficient or rational forecasts of future spot rates. However, as one bright spot, we cannot reject efficiency and rationality for the U.S. dollar forward rate for the Canadian dollar.

Forward-rate target zones and exchange rate dynamics

A target zone for the forward exchange rate is developed using a log-linear monetary model. Exchange rates are driven by a Wiener process. A central bank purchases or sells foreign exchange forward to keep the target forward rate in a specified band. Defending such a target zone does not require regulated Wiener process, for the central bank's forward exchange intervention can avoid disturbing the money supply. A forward-rate target zone can stabilize the spot rate against a free float and its stabilizing effects become more significant if the delivery term applying to the target forward rate is shorter.

How do IMF announcements affect financial markets in crises?: Evidence from forward exchange markets

We employ a theoretical model to interpret the liquidity and moral hazard effects of IMF support during a financial crisis. We then estimate the response of forward exchange markets to IMF-related announcements, using data on the 3-, 9-, and 12-month forward exchange rates. Our results indicate that the announcement of IMF negotiations is associated with a premium on the baht and the rupiah, where the premium is much larger on the latter. This result is largely consistent with the responses of stock and bond markets, especially when country-specific data are employed.