Predictor Of Future Spot Rate Research Articles

How puzzling is the forward premium puzzle? A meta-analysis

A key theoretical prediction in financial economics is that under risk neutrality and rational expectations a currency’s forward rates should form unbiased predictors of future spot rates. Yet scores of empirical studies report negative slope coefficients from regressions of spot rates on forward rates. We collect 3643 estimates from 91 research articles and using recently developed techniques investigate the effect of publication and misspecification biases on the reported results. Correcting for these biases yields slope coefficients in the intervals (0.23,0.45) and (0.95,1.16) for the currencies of developed and emerging countries respectively, which implies that empirical evidence is in line with the theoretical prediction for emerging economies and less puzzling than commonly thought for developed economies. Our results also suggest that the coefficients are systematically influenced by the choice of data, numeraire currency, and estimation method.

How Puzzling is the Forward Premium Puzzle? A Meta-Analysis

A key theoretical prediction in financial economics is that under risk neutrality and rational expectations, a currency's forward rates should form unbiased predictors of future spot rates. Yet scores of empirical studies report negative slope coefficients from regressions of spot rates on forward rates, which is inconsistent with the forward rate unbiasedness hypothesis. We collect 3,643 estimates from 91 research articles and using recently developed techniques investigate the effect of publication and misspecification biases on the reported results. Correcting for these biases yields slope coefficients of 0.31 and 0.98 for developed and emerging currencies respectively, which implies that empirical evidence is in line with the theoretical prediction for emerging economies and less puzzling than commonly thought for developed economies. Our results also suggest that the coefficients are systematically influenced by the choice of data, numeraire currencies, and estimation methods. The findings can be applied to calibrating carry trade strategies for individual currencies.

Reforming Indian Foreign Exchange Market: A Survey

The process of economic reform in India embraced also the foreign exchange market. The present paper analyzes the reform measures and their impact in this context. The measures of reform included, inter alia, adoption of managed floating exchange rate arrangement, rationalization of the very structure of the market, introduction of variety of activities, such as options and swaps, etc., gradual move towards the capital account convertibility and infusion of stability in the market. The study finds the outcome very positive. The turnover of the transactions surged up more especially in the inter-bank segment. The foreign exchange market in India moved towards greater efficiency in view of reduced bid-ask spread, forward premia, being to a great extent, in line with the interest rate differentials and being, to a great deal, a predictor of future spot rate, and a lower degree of the RBIRBIâ€'s intervention giving way to the free play of market forces. Nevertheless, oscillations in foreign exchange transaction should be checked in order to transfuse greater stability in the Indian foreign exchange market.

Forward interest rate premium and asymmetric adjustment: Evidence from 16 countries

This paper examines the ability of the forward premium to provide an unbiased estimate of the future spot rate allowing for potential asymmetries. Extant evidence suggests that forward rates provide a biased predictor of future spot rates. Examining the forward premium for 16 countries, only for 2 countries does the linear expectations hypothesis holds. For the remaining countries, results generally support the view that the larger the forward premium the better a predictor for future spot rates it is, however, this result is not unique across all countries. Furthermore, although the asymmetric model improves data fit over the linear model, only in four cases does the model support an unbiased predictor interpretation. Further research is therefore required to understand the nature of this relationship, not least given the importance of correctly priced forward and long rates in terms of expected returns to future investments and the conduct of monetary policy.

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A test of the expectations hypothesis of the term structure of interest rates for Sri Lanka

This paper tests the expectations hypothesis of the term structure of interest rates for Sri Lanka. The data support the hypothesis that forward and spot rates are cointegrated suggesting a stochastic trend in the structure of interest rates. However, the hypothesis that forward rates are unbiased predictors of future spot rates is rejected.

Violations of Uncovered Interest Parity: Are They Pervasive, and are They a Money Tree

This study contributes to the literature by casting a wider net in, and adopting a novel approach to, examining violations of uncovered interest parity (UIP). Relative to its predecessors, the analysis presented in this paper is based on a larger number of exchange rates, a wider range of tests, and also includes a simple real-world trading experiment assessing whether strategies designed to exploit the breakdown of UIP have been profitable. The study reveals a host of intriguing results, based largely on cross exchange rates not previously examined in this context. First, forward rates of industrialized countries are unambiguously biased predictors of future spot rates, as spot rates invariably depreciate (appreciate) by less than the amount implied by the forward discount (premium). This indicates violations of UIP are ubiquitous and not simply restricted to the key currency blocks which have already been studied. Second, contrary to popular belief, the forward 'puzzle' anomaly - where high yielding currencies appreciate, not depreciate as UIP predicts - is not a pervasive phenomenon. Third, regression results and the trading experiment demonstrate that deviations from UIP are both size and time dependent. For instance, during points in time where interest differentials have been relatively large, UIP correctly predicts the sign, but not the magnitude, of exchange rate changes. More recently, the breakdown of UIP has become increasingly severe as interest differentials have converged around the world. Finally, results from the trading experiment demonstrate that in contrast to US dollar based findings presented in earlier studies, strategies exploiting the forward bias have in fact been something of a money tree - deviations from UIP have been large and consistent enough to generate impressive profits and risk-return tradeoffs for simple multi-currency trading strategies.

Forward Discount Bias, Nalebuff's Envelope Puzzle, and the Siegel Paradox in Foreign Exchange

Abstract The bias of forward exchange rates as a predictor of future spot rates is typically explained or decomposed as (1) a risk premium and (2) a convexity term which accounts for the fact that, when there is stochastic inflation, nominal gains from forward currency speculation are higher than real ones and correspondingly losses are smaller. We use Nalebuff’s envelope puzzle to explain a third source of bias which involves real profits from foreign exchange speculation. Both the "real profit" bias and stochastic inflation bias arise from convexity of g(s)=1/s and so derive from Jensen's inequality as observed by Siegel (1972).

Cointegration, unbiased expectations, and forecasting in the BIFFEX freight futures market

The relationship between freight cash and futures prices is investigated using cointegration econometrics. Results illustrate that the BIFFEX futures market is unbiased, and hence efficient for the current, one, two, and quarterly contract horizons. Since the futures contract is based on an index of various shipping routes, which has undergone several changes since its inception, stability in the relationship between the spot and futures rates is investigated using rolling cointegration techniques. Results indicate that the futures contract appears to have become more efficient over time in predicting the spot rate, and that the decrease in trading volume found in the BIFFEX market is not driven by a lack of efficiency in this market. Rather, the decrease in futures trading might be attributed to the growth rate of the freight forward market. This article incorporates the long‐run cointegrating relationships between cash and futures prices in a forecasting model and compares the forecasting performance of this model with several alternatives. It is found that while the futures price is the best predictor of future spot rates for the current‐month contract, time‐series models can outperform the futures contract at longer contract horizons. © 2000 John Wiley & Sons, Inc. Jrl Fut Mark 20:545–571, 2000.

Heterogeneous expectations and tests of efficiency in the yen/dollar forward exchange rate market

This paper examines the efficiency of the forward yen/dollar market using micro survey data. Conventional tests of unbiasedness do not correspond directly to the zero-profit condition. Instead, we use the survey data to calculate potential profits of individual forecasters based on a natural trading rule. We find that although the survey data are not the best predictor of future spot rates in terms of typical mean square forecast error criteria, the survey data can be used to obtain on average positive profits. However, these profits are small and highly variable. Similar results are found when we examine profits generated by a trading rule using regression forecasts. The profits are found to be correlated with risk type variables but not other available information.

Spot and forward exchange rates as predictors of future spot rates: trends in exchange market value and the contribution of new information

This study investigates whether or not new information affects the predictive capability of forward and spot foreign exchange rates symmetrically during periods of rising as opposed to falling currency values. Statistically significant different intercept and slope coefficients are found between the periods of U.S. dollar appreciation and U.S. dollar depreciation. Further, the predictive ability of the two models differs between opposite trends in foreign exchange values.

Adjusted Forward Rates as Predictors of Future Spot Rates

Prior studies indicate that the predictive power of implied forward rates for future spot rates is weak over long sample periods and typically varies dramatically across different subperiods. Fama (1976, 1984) conjectures that the low forecast power is due to a failure to control for the term premium embedded in forward rates. We show that Fama's conjecture is consistent with the data using any of four different models of the term premium. We measure the term premium using a variety of ex ante instruments, including the junk bond premium,bid-ask spreads in Treasury bills, the Standard & Poor's 500 stock index's dividend yield and the conditional volatility of interest rate changes using an Autoregressive Conditionally Heteroscedastic (ARCH) process. Forward rates adjusted for the term premium are reliable predictors of future spot rates over the entire 1963-1993 period.

Adjusted Forward Rates as Predictors of Future Spot Rates

Adjusted Forward Rates as Predictors of Future Spot Rates

Adjusted Forward Rates as Predictors of Future Spot Rates

Prior studies indicate that the predictive power of implied forward rates for future spot rates is weak over long sample periods and typically varies dramatically across different subperiods. Fama (1976, 1984) conjectures that the low forecast power is due to a failure to control for the term premium embedded in forward rates. We show that Fama’s conjecture is consistent with the data using any of four different models of the term premium. We measure the term premium using a variety of ex ante instruments, including the junk bond premium, bid-ask spreads in Treasury bills, the Standard & Poor’s 500 stock index’s dividend yield and the conditional volatility of interest rate changes using an Autoregressiv e Conditionally Heteroscedastic (ARCH) process. Forward rates adjusted for the term premium are reliable predictors of future spot rates over the entire 1963-1993 period.

Testing the unbiasedness hypothesis of foreign exchange rates and the analysis of transformations

Recent researchers have utilized various functional forms for testing the hypothesis that the forward rate is an unbiased predictor of future spot rates in foreign exchange markets. We compare a large number of these functional forms for a similar time period and test their consistency with the data for five major currencies. Our results imply that certain functional form models may be inappropriate for some currencies. Researchers must, therefore, be cautious of misspecification due to erroneous functional forms when testing the unbiased forward rate hypothesis.

SPECULATIVE EFFICIENCY ON THE LONDON METAL EXCHANGE*

This paper examines the proposition that forward rates are unbiased predictors of future spot rates for base metal prices on the London Metal Exchange. The analysis is complicated by the fact that the data are sampled more frequently than the life of the forward contracts. Though the implications of this for stationary inference are well known, it has not yet been addressed within the context of unit root econometrics. This is explored and an estimation and testing strategy is proposed. The results are surprisingly favorable to the unbiasedness proposition. Copyright 1995 by Blackwell Publishers Ltd and The Victoria University of Manchester

On the importance of the term premium in the T-bill market

The relative importance of expectations and term premia as components of forward interest and exchange rates is a contentious issue. We show that this is due to differences in the way importance is defined, and expectations measured. Survey data on US Treasury bill rate forecasts suggest that the rational expectations assumption has led researchers to overestimate the importance of term premia. Term premia are no more important than expectations in explaining the spread between spot and forward rates, and contribute little to the error in the forward rate as a predictor of future spot rates

A reconsideration of the uncovered interest parity relationship

This paper argues that the uncovered interest parity (UIP) relationship is distinct from, and more important than, the unbiasedness of forward exchange rates as predictors of future spot rates. The standard finding that the slope estimate ĝb is roughly - 3 in regressions of Δ s t on ƒ t−1 − s t−1 implies rejection of unbiasedness but not necessarily UIP. The hypothesis that monetary authorities manage interest rates so as to smooth their movements, while also resisting changes in exchange rates, is attractive conceptually and is capable of explaining not only theĝb = −3 finding but also several other notable features of the data.

FORWARD RISK PREMIA AND THE MATURITY OF CONTRACTS: A NOTE

This paper examines the behavior of the risk premium component of currency forward rates. Analyzing forward rates of one, two and three‐month maturity, we find that the power of forward rate as a predictor of future spot rate decreases with the length of contract maturity. Further, we find that the proportion of the variance of the forward premium which is due to the variation of the risk premium is larger than the proportion due to the expected spot rate change for all currencies except for the Canadian dollar. This proportion also increases with the length of maturity.

Tax wedges, bid-ask spreads, and international financial parity conditions

Tax wedges do not induce a priori inconsistencies in the international Fisher effect nor do they render forward rates biased predictors of future spot rates once proper account is taken of the bid-ask spreads present in spot and forward foreign currency transactions.