How Puzzling is the Forward Premium Puzzle? A Meta-Analysis
61 Pages Posted: 1 Mar 2021
Date Written: February 2021
A key theoretical prediction in financial economics is that under risk neutrality and rational expectations a currency's forward rates should form unbiased predictors of future spot rates. Yet scores of empirical studies report negative slope coefficients from regressions of spot rates on forward rates. We collect 3,643 estimates from 91 research articles and using recently developed techniques investigate the effect of publication and misspecification biases on the reported results. Correcting for these biases yields slope coefficients in the intervals (0.23,0.45) and (0.95,1.16) for the currencies of developed and emerging countries respectively, which implies that empirical evidence is in line with the theoretical prediction for emerging economies and less puzzling than commonly thought for developed economies. Our results also suggest that the coefficients are systematically influenced by the choice of data, numeraire currency, and estimation method.
JEL Classification: C83, F31, G14
Suggested Citation: Suggested Citation