Understanding the Forward Premium Puzzle: A Microstructure Approach

33 Pages Posted: 30 May 2008

See all articles by A. Craig Burnside

A. Craig Burnside

Duke University - Department of Economics; University of Glasgow - Department of Economics; National Bureau of Economic Research (NBER)

Martin Eichenbaum

Northwestern University; National Bureau of Economic Research (NBER)

Sergio T. Rebelo

Northwestern University - Kellogg School of Management; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: July 2007

Abstract

High-interest-rate currencies tend to appreciate relative to low-interest-rate currencies. We argue that adverse-selection problems between participants in foreign exchange markets can account for this 'forward premium puzzle.' The key feature of our model is that the adverse selection problem facing market makers is worse when, based on public information, a currency is expected to appreciate.

Keywords: Exchange rates, microstructure, Uncovered interest parity

JEL Classification: F31

Suggested Citation

Burnside, Craig and Eichenbaum, Martin and Tavares Rebelo, Sergio, Understanding the Forward Premium Puzzle: A Microstructure Approach (July 2007). , Vol. , pp. -, 2007. Available at SSRN: https://ssrn.com/abstract=1137080

Craig Burnside (Contact Author)

Duke University - Department of Economics ( email )

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University of Glasgow - Department of Economics

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Martin Eichenbaum

Northwestern University ( email )

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National Bureau of Economic Research (NBER)

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Sergio Tavares Rebelo

Northwestern University - Kellogg School of Management ( email )

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847-491-5719 (Fax)

Centre for Economic Policy Research (CEPR)

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United Kingdom

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

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