How Puzzling is the Forward Premium Puzzle? A Meta-Analysis

61 Pages Posted: 1 Mar 2021

See all articles by Tomas Havranek

Tomas Havranek

Charles University in Prague; Centre for Economic Policy Research (CEPR)

Zuzana Irsova

Charles University in Prague

Jiri Novak

Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Czech Republic

Diana Zigraiova

Charles University in Prague; European Stability Mechanism

Date Written: February 2021

Abstract

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

Havranek, Tomas and Irsova, Zuzana and Novak, Jiri and Zigraiova, Diana and Zigraiova, Diana, How Puzzling is the Forward Premium Puzzle? A Meta-Analysis (February 2021). Available at SSRN: https://ssrn.com/abstract=3795200

Tomas Havranek (Contact Author)

Charles University in Prague ( email )

Celetná 13
Praha 1, 116 36
Czech Republic

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Zuzana Irsova

Charles University in Prague ( email )

Celetná 13
Praha 1, 116 36
Czech Republic

Jiri Novak

Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Czech Republic ( email )

Opletalova 1606/26
Praha 1, 11000
Czech Republic
+420 222 112 314 (Phone)

HOME PAGE: http://ies.fsv.cuni.cz/cs/staff/novakji

Diana Zigraiova

Charles University in Prague ( email )

Celetná 13
Praha 1, 116 36
Czech Republic

European Stability Mechanism ( email )

6a Circuit de la Foire Internationale
L-1347
Luxembourg

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