Time Horizon Sensitivity of the Forward Premium Puzzle
39 Pages Posted: 26 Aug 2007 Last revised: 20 Oct 2007
Date Written: August 2007
Abstract
Motivated by a consumption-based asset pricing model, this paper checks the time horizon sensitivity of the forward premium puzzle from 1994 to 2004. The in-sample estimation shows that the longer the time horizon (up to 1 year), the more the future spot exchange return deviates from its associated forward premium. The out-of-sample forecast performance of the forward premium regression (with unconstrained coefficients), on the other hand, improves as the forecast horizon lengthens. More importantly, the evidence shows that the random walk model is likely out-performed by the forward premium model at horizons longer than one month.
Keywords: Forward Premium Puzzle, Uncovered Interest Parity, Exchange Rate Forecast
JEL Classification: C53, F31, G12
Suggested Citation: Suggested Citation
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