Abstract

http://ssrn.com/abstract=2272893
 
 

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Forward and Spot Exchange Rates in a Multi-Currency World


Tarek A. Hassan


University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Rui C. Mano


International Monetary Fund

April 6, 2015

Fama-Miller Working Paper
Chicago Booth Research Paper No. 15-02

Abstract:     
Separate literatures study violations of uncovered interest parity using regression-based and portfolio-based methods. We propose a decomposition of these violations into a cross-currency, a between-time-and-currency, and a cross-time component that allows us to analytically relate regression-based and portfolio-based anomalies, to test whether they are empirically distinct, and to estimate the joint restrictions they place on models of currency returns. We find that the forward premium puzzle (FPP) and the "dollar trade'' anomaly are intimately linked. Both anomalies are almost exclusively driven by the cross-time component. By contrast, the ``carry trade'' anomaly is driven largely by the cross-currency component. Our decomposition also reveals a large upward bias in standard quantifications of the FPP. Once we correct for this bias, the puzzle is significantly diminished --- to the point that it does not require a systematic association between currency risk premia and expected depreciations. The simplest model that the data do not reject features a highly persistent asymmetry that makes some currencies pay higher expected returns than others, and a more elastic expected return on the US dollar than on other currencies.

Number of Pages in PDF File: 68

Keywords: Carry Trade, Forward Premium Puzzle, Uncovered Interest Parity

JEL Classification: F31, G12, G15


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Date posted: June 2, 2013 ; Last revised: April 7, 2015

Suggested Citation

Hassan, Tarek A. and Mano, Rui C., Forward and Spot Exchange Rates in a Multi-Currency World (April 6, 2015). Fama-Miller Working Paper; Chicago Booth Research Paper No. 15-02. Available at SSRN: http://ssrn.com/abstract=2272893 or http://dx.doi.org/10.2139/ssrn.2272893

Contact Information

Tarek Alexander Hassan (Contact Author)
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
HOME PAGE: http://faculty.chicagobooth.edu/tarek.hassan/index.html
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Centre for Economic Policy Research (CEPR) ( email )
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
Rui C. Mano
International Monetary Fund ( email )
700 19th Street, N.W.
Washington, DC 20431
United States
HOME PAGE: http://sites.google.com/site/ruimano/
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