Forward and Spot Exchange Rates in a Multi-Currency World

86 Pages Posted: 24 Jul 2014

See all articles by Tarek A. Hassan

Tarek A. Hassan

Boston University; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Rui C. Mano

International Monetary Fund

Multiple version iconThere are 3 versions of this paper

Date Written: July 2014


Separate literatures study violations of uncovered interest parity (UIP) using regression-based and portfolio-based methods. We propose a decomposition of these violations into a cross-currency, a between-time-and-currency, and a cross-time component that allows us to analytically relate regression-based and portfolio-based facts, and to estimate the joint restrictions they place on models of currency returns. Subject to standard assumptions on investors’ information sets, we find that the forward premium puzzle (FPP) and the “dollar trade” anomaly are intimately linked: both are driven almost exclusively by the cross-time component. By contrast, the “carry trade” anomaly is driven largely by cross-sectional violations of UIP. The simplest model the data do not reject features a cross-sectional asymmetry that makes some currencies pay permanently higher expected returns than others, and larger time series variation in expected returns on the US dollar than on other currencies. Importantly, conventional estimates of the FPP are not directly informative about expected returns, because they do not correct for uncertainty about future mean interest rates. Once we correct for this uncertainty, we never reject the null that investors expect high-interest-rate currencies to depreciate, not appreciate.

Suggested Citation

Hassan, Tarek Alexander and Mano, Rui C., Forward and Spot Exchange Rates in a Multi-Currency World (July 2014). NBER Working Paper No. w20294. Available at SSRN:

Tarek Alexander Hassan (Contact Author)

Boston University ( email )

270 Bay State Road
Boston, MA 02215
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
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Centre for Economic Policy Research (CEPR) ( email )

United Kingdom

Rui C. Mano

International Monetary Fund ( email )

700 19th Street, N.W.
Washington, DC 20431
United States


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