36 Pages Posted: 21 Sep 2009
Date Written: July 24, 2009
Many studies have replicated the finding that the forward rate is a biased predictor of the future change in the spot exchange rate. Usually the forward discount actually points in the wrong direction. But, at least until recently, those studies applied only to advanced economies and major currencies. We apply the same tests to a sample of 14 emerging market currencies. We find a smaller bias than for advanced country currencies. The coefficient is on average positive, i.e., the forward discount at least points in the right direction. It is never significantly less than zero. To us this suggests that a time-varying exchange risk premium may not be the explanation for traditional findings of bias. The reasoning is that emerging markets are probably riskier; yet we find that the bias in their forward rates is smaller. Emerging market currencies probably have more easily-identified trends of depreciation than currencies of advanced countries.
Keywords: forward discount, forward premium, bias, puzzle, emerging markets, uncovered interest parity, exchange risk premium, exchange rate
JEL Classification: F31
Suggested Citation: Suggested Citation
Frankel, Jeffrey A. and Poonawala, Jumana, The Forward Market in Emerging Currencies: Less Biased than in Major Currencies (July 24, 2009). HKS Working Paper No. RWP09-023. Available at SSRN: https://ssrn.com/abstract=1474849 or http://dx.doi.org/10.2139/ssrn.1474849
By Karen Lewis