The Forex Forward Puzzle: The Career Risk Hypothesis

34 Pages Posted: 9 Jul 2009

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Abstract

We conjecture that the forward puzzle may reflect career risks. When professional investors observe public danger signals about a currency, they require a premium for holding it. We find evidence of this in Exchange Rate Mechanism rates. As deep discounts do signal danger, we next specify nonlinear variants of the Fama regression to capture this risk. We also decompose the forward premium into a long-memory trend and short-term component. We find empirical evidence for a career risk premium; risk is in fact dominant in the trend component while the short-term component loads more on expectations. All confidence intervals are calculated via Monte Carlo.

Suggested Citation

Liu, Fang and Sercu, Piet M. F. A., The Forex Forward Puzzle: The Career Risk Hypothesis. Financial Review, Vol. 44, Issue 3, pp. 371-404, August 2009, Available at SSRN: https://ssrn.com/abstract=1432236 or http://dx.doi.org/10.1111/j.1540-6288.2009.00222.x

Fang Liu

KU Leuven ( email )

Oude Markt 13
Leuven, Vlaams-Brabant 3000
Belgium

Piet M. F. A. Sercu

FEB at KU Leuven ( email )

Naamsestraat 69
Faculty of Economics and Business
Leuven, 3000
Belgium
+32 16 32 67 56 (Phone)
+32 16 32 67 32 (Fax)

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