The Information in Long-Maturity Forward Rates: Implications for Exchange Rates and the Forward Premium Anomaly

33 Pages Posted: 13 Nov 2008

See all articles by Jacob Boudoukh

Jacob Boudoukh

Interdisciplinary Center (IDC) Herzliyah; AQR Capital Management, LLC

Matthew P. Richardson

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER); AQR Capital Management, LLC

Robert Whitelaw

New York University; National Bureau of Economic Research (NBER)

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Date Written: November 2005

Abstract

The forward premium anomaly is one of the most robust puzzles in financial economics. We recast the underlying parity relation in terms of cross-country differences between forward interest rates rather than spot interest rates with dramatic results. These forward interest rate differentials have statistically and economically significant forecast power for annual exchange rate movements, both in- and out-of-sample, and the signs and magnitudes of the corresponding coefficients are consistent with economic theory. Forward interest rates also forecast future spot interest rates and future inflation. Thus, we attribute much of the forward premium anomaly to the anomalous behavior of shortterm interest rates, not to a breakdown of the link between fundamentals and exchange rates.

Suggested Citation

Boudoukh, Jacob and Richardson, Matthew P. and Whitelaw, Robert F., The Information in Long-Maturity Forward Rates: Implications for Exchange Rates and the Forward Premium Anomaly (November 2005). NYU Working Paper No. S-DRP-05-06. Available at SSRN: https://ssrn.com/abstract=1300739

Jacob Boudoukh (Contact Author)

Interdisciplinary Center (IDC) Herzliyah ( email )

P.O. Box 167
Herzliya, 46150
Israel

AQR Capital Management, LLC ( email )

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United States

Matthew P. Richardson

New York University (NYU) - Department of Finance ( email )

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National Bureau of Economic Research (NBER)

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AQR Capital Management, LLC ( email )

Greenwich, CT
United States

Robert F. Whitelaw

New York University ( email )

Stern School of Business
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New York, NY 10012-1126
United States
212-998-0338 (Phone)
212-995-4233 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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