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A Complete Solution To The Forward-Bias Puzzle

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  • Pippenger, John
Abstract
A complete solution to the forward-bias puzzle should provide an econometric solution and an economic explanation for that solution. A complete solution should also explain the closely related failure of uncovered interest parity. In addition it should explain some related anomalies. One such anomaly is that variances for changes in exchange rates are over 100 times larger than variances for interest rate differentials and forward premiums. My econometric solution is that the relevant test equations omit two variables that covered interest parity implies should be included. For my data, the missing variables explain the failure of uncovered interest parity and the forward-bias puzzle. The missing variables also explain why the variance for changes in exchange rates is over 100 times larger than the variance for both interest rate differentials and forward premiums. My economic explanation is that, in general, forward rates do not equal expected future spot rates.

Suggested Citation

  • Pippenger, John, 2011. "A Complete Solution To The Forward-Bias Puzzle," University of California at Santa Barbara, Economics Working Paper Series qt5gq9z4j0, Department of Economics, UC Santa Barbara.
    • Handle: RePEc:cdl:ucsbec:qt5gq9z4j0
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    Cited by:

    1. Zigraiova, Diana & Havranek, Tomas & Irsova, Zuzana & Novak, Jiri, 2021. "How puzzling is the forward premium puzzle? A meta-analysis," European Economic Review, Elsevier, vol. 134(C).
    2. Alan, King, 2011. "A comment on: "The solution to the forward-bias puzzleâ," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 21(4), pages 623-628, October.
    3. Grossmann, Axel & Lee, Allissa A. & Simpson, Marc W., 2014. "Forward premium anomaly of the British pound and the euro," International Review of Financial Analysis, Elsevier, vol. 34(C), pages 140-156.
    4. Sanders S., Chang, 2011. "On the (in)feasibility of covered interest parity as a solution to the forward bias puzzle," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 21(4), pages 611-616, October.
    5. Shehadeh, Ali & Li, Youwei & Moore, Michael, 2016. "The Forward Premium Bias, Carry Trade Return and the Risks of Volatility and Liquidity," MPRA Paper 71709, University Library of Munich, Germany.
    6. Shehadeh, Ali A. & Li, Youwei & Vigne, Samuel A. & Almaharmeh, Mohammad I. & Wang, Yizhi, 2021. "The existence and severity of the forward premium puzzle during tranquil and turbulent periods: Developed versus developing country currencies," International Review of Financial Analysis, Elsevier, vol. 78(C).
    7. Nagayasu, Jun, 2012. "Long-Run Implications of the Covered Interest Rate Parity Condition: Evidence during the Recent Crisis and Non-Crisis Periods," MPRA Paper 41566, University Library of Munich, Germany.
    8. Simpson, Marc W. & Grossmann, Axel, 2014. "An examination of the forward prediction error of U.S. dollar exchange rates and how they are related to bid-ask spreads, purchasing power parity disequilibria, and forward premium asymmetry," The North American Journal of Economics and Finance, Elsevier, vol. 28(C), pages 221-238.
    9. Zhao, Yanping & de Haan, Jakob & Scholtens, Bert & Yang, Haizhen, 2013. "The relationship between the Renminbi future spot return and the forward discount rate," Journal of International Money and Finance, Elsevier, vol. 32(C), pages 156-168.
    10. Brian Lucey & Grace Loring, 2012. "Forward Exchange Rate Biasedness across Developed and Developing Country Currencies - Do Observed Patterns Persist Out of Sample?Abstract:," The Institute for International Integration Studies Discussion Paper Series iiisdp404, IIIS.
    11. Li, Jing & Miller, Norman C., 2015. "Foreign exchange market inefficiency and exchange rate anomalies," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 34(C), pages 311-320.
    12. Reus, Lorenzo & Mulvey, John M., 2016. "Dynamic allocations for currency futures under switching regimes signals," European Journal of Operational Research, Elsevier, vol. 253(1), pages 85-93.
    13. Norman C. Miller, 2014. "Exchange Rate Economics," Books, Edward Elgar Publishing, number 14981.
    14. Dominique Torre, 2012. "The monetary views of Paul Einzig," Post-Print halshs-00726126, HAL.
    15. Christian, Müller, 2011. "The forward-bias puzzle: Still unsolved," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 21(4), pages 605-610, October.
    16. King, Alan, 2011. "Pippenger's CIP-based solution to the forward-bias puzzle: A rejoinder," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 21(5), pages 867-873.
    17. Kumar, Satish & Trück, Stefan, 2014. "Unbiasedness and risk premiums in the Indian currency futures market," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 29(C), pages 13-32.
    18. John, Pippenger, 2011. "The solution to the forward-bias puzzle: Reply," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 21(4), pages 629-636, October.
    19. Loring, Grace & Lucey, Brian, 2013. "An analysis of forward exchange rate biasedness across developed and developing country currencies: Do observed patterns persist out of sample?," Emerging Markets Review, Elsevier, vol. 17(C), pages 14-28.
    20. Kumar, Satish, 2019. "Does risk premium help uncover the uncovered interest parity failure?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 63(C).
    21. Pippenger, John, 2013. "The Failure Of Uncovered Interest Parity, Forward Bias And Related Puzzles," University of California at Santa Barbara, Economics Working Paper Series qt50n5p8bv, Department of Economics, UC Santa Barbara.

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