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The Forward Exchange Rate Bias Puzzle is Persistent: Evidence from Stochastic and Non Parametric Cointegration TestsRaj AggarwalUniversity of Akron - Department of Finance Brian M. LuceyTrinity College, Dublin - School of Business; University of Dublin - Institute for International Integration Studies (IIIS); Glasgow Caledonian University - Division of Accounting & Finance Sunil MohantyUniversity of St. Thomas (Minnesota) - Opus College of Business February 2006 IIIS Discussion Paper No. 122 Abstract: An important puzzle in international finance is the failure of the forward exchange rate to be a rational forecast of the future spot rate. It has often been suggested that this puzzle may be resolved by using better statistical procedures that correct for both non-stationarity and nonnormality in the data. We document that even after accounting for non-stationarity, nonnormality, and heteroscedasticity using parametric and non-parametric tests on data for over a quarter century, US dollar forward rates for horizons ranging from one to twelve months for the major currencies, the British pound, Japanese yen, Swiss franc, and the German mark, are generally not rational forecasts of future spot rates. These findings of non-rationality in forward exchange rates for the major currencies continue to be puzzling especially as these foreign exchange markets are some of the most liquid asset markets with very low trading costs.
Number of Pages in PDF File: 25 JEL Classification: F31, G14, F47, G15 working papers seriesDate posted: August 8, 2006Suggested CitationContact Information
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