The Forward Exchange Rate Bias Puzzle is Persistent: Evidence from Stochastic and Non Parametric Cointegration Tests

25 Pages Posted: 8 Aug 2006

See all articles by Raj Aggarwal

Raj Aggarwal

University of Akron; Federal Reserve Banks - Federal Reserve Bank of Cleveland

Brian M. Lucey

Trinity Business School, Trinity College Dublin; University of Sydney Business School; University of Economics Ho Chi Minh City

Sunil Mohanty

University of St. Thomas - Opus College of Business

Date Written: February 2006

Abstract

An important puzzle in international finance is the failure of the forward exchange rate to be a rational forecast of the future spot rate. It has often been suggested that this puzzle may be resolved by using better statistical procedures that correct for both non-stationarity and nonnormality in the data. We document that even after accounting for non-stationarity, nonnormality, and heteroscedasticity using parametric and non-parametric tests on data for over a quarter century, US dollar forward rates for horizons ranging from one to twelve months for the major currencies, the British pound, Japanese yen, Swiss franc, and the German mark, are generally not rational forecasts of future spot rates. These findings of non-rationality in forward exchange rates for the major currencies continue to be puzzling especially as these foreign exchange markets are some of the most liquid asset markets with very low trading costs.

JEL Classification: F31, G14, F47, G15

Suggested Citation

Aggarwal, Raj and Lucey, Brian M. and Mohanty, Sunil K., The Forward Exchange Rate Bias Puzzle is Persistent: Evidence from Stochastic and Non Parametric Cointegration Tests (February 2006). IIIS Discussion Paper No. 122. Available at SSRN: https://ssrn.com/abstract=922302 or http://dx.doi.org/10.2139/ssrn.922302

Raj Aggarwal (Contact Author)

University of Akron ( email )

Akron, OH 44325-4803
United States

Federal Reserve Banks - Federal Reserve Bank of Cleveland ( email )

East 6th & Superior
Cleveland, OH 44101-1387
United States

Brian M. Lucey

Trinity Business School, Trinity College Dublin ( email )

The Sutherland Centre, Level 6, Arts Building
Dublin 2
Ireland
+353 1 608 1552 (Phone)
+353 1 679 9503 (Fax)

University of Sydney Business School ( email )

Cnr. of Codrington and Rose Streets
Sydney, NSW 2006
Australia

University of Economics Ho Chi Minh City ( email )

59C Nguyen D├Čnh Chieu
6th Ward, District 3
Ho Chi Minh City, Ho Chi Minh 70000
Vietnam

Sunil K. Mohanty

University of St. Thomas - Opus College of Business ( email )

1000 LaSalle Avenue
TMH 443
Minneapolis, MN 55403
United States

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