Skip to main content
Article thumbnail
Location of Repository

The Forward Rate Premium Puzzle: A Resolution

By Stephen G. Hall, P. A. V. B. Swamy, George S. Tavlas and Amangeldi Kenjegaliev


Empirical studies report that there is a negative relationship between the spot difference and forward premium. This result violates the forward rate unbiasedness theory. Using standard regression we found that recent samples give mixed results with both positive and negative coefficients. One possibility is that the negative coefficients could arise due to the non-linearities in the series and misspecification. To overcome these problems we employed a relatively novel technique. As an alternative to the standard regression we used a time-varying coefficient technique. This methodology estimates bias-free coefficients and thus should provide better estimates of the link between spot and forward rates. The findings of the time-varying coefficient model strongly support the forward rate unbiasedness hypothesis. All the parameters are very close to unity and significant. At the same time our results do not violate the efficient market theory

Topics: Forward premium anomaly, Time-varying coefficients, spurious relationships
Publisher: Dept. of Economics, University of Leicester
Year: 2011
OAI identifier:

Suggested articles


  1. (2000). A computational approach to finding causal economic laws. doi
  2. (1975). An Instrumental Variable Approach to Full Information Estimators for Linear and Certain Nonlinear Econometric Models, doi
  3. (1988). Causality and causal laws in economics. doi
  4. (1979). Causality and econometrics. doi
  5. (1988). Causality tests and observationally equivalent representations of econometric models, doi
  6. (2003). Consistent estimation with a large number of weak instruments, doi
  7. (2003). Econometric analysis, 5th edition, Upper Saddle River,
  8. (1992). Efficient computation of stochastic coefficient models. In: doi
  9. (2010). Estimation of parameters in the presence of model misspecification and measurement error. doi
  10. (2006). Federal Reserve Board (Retired),
  11. (1984). Forward and spot exchange rates. doi
  12. (1989). Forward Discount Bias: Is it an Exchange Risk Premium? The Quarterly doi
  13. (2003). Introduction to Econometrics. doi
  14. (2007). Learning, forward premium puzzle and exchange rate fundamentals under sticky prices,
  15. (2009). Learning, the forward premium puzzle, and market efficiency. doi
  16. (2007). Methods of distinguishing between spurious regressions and causality.
  17. (2006). Nonlinearity in Deviations from Uncovered Interest Parity: An Explanation of the Forward Bias Puzzle. doi
  18. (1988). On the interpretation and observation of laws. doi
  19. (1984). On the nature and discovery of structure. doi
  20. (1995). Random coefficient models: Theory and applications. doi
  21. (2001). Random coefficient models. In: doi
  22. (1974). Spurious regressions in econometrics. doi
  23. (2001). Testing for weak instruments in linear IV regression. NBER working papers doi
  24. (1981). The "Speculative Efficiency" Hypothesis , doi
  25. (1986). The covariation of risk premiums and expected future spot exchange rates. doi
  26. (2010). The Fisher effect puzzle: A case of non-linear relationship? doi
  27. (1996). The forward discount anomaly and the risk premium: A survey of recent evidence. doi
  28. (2010). The forward market in emerging currencies: Less biased than in major currencies, doi
  29. (2009). The Nonexistence of Instrumental Variables, doi

To submit an update or takedown request for this paper, please submit an Update/Correction/Removal Request.