The Forward Premium Puzzle and Latent Factors Day by Day
German Institute for Economic Research (DIW Berlin)
Casper G. De Vries
Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE); Tinbergen Institute; CESifo (Center for Economic Studies and Ifo Institute)
Jürgen Von Hagen
University of Bonn - Institute of Economic Policy; Centre for Economic Policy Research (CEPR)
CEPR Discussion Paper No. DP7772
We use futures instead of forward rates to study the complete maturity spectrum of the forward premium puzzle from two days to six months. At short maturities, the slope coefficient is positive, but it turns negative as the maturity increases to the monthly level. Futures data allow us to control for the influence of an unobserved factor that can be decomposed into a contract-specific and a time-to-maturity effect. Once we do this, we find that the coefficients on the forward premium are much closer to one. The latent factor is shown to be related to conventional proxies of risk.
Number of Pages in PDF File: 40
Keywords: forward premium puzzle, futures rates, latent factor
JEL Classification: F31, F37, G13working papers series
Date posted: April 12, 2010
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