The Spot-Forward Exchange Rate Relation in Indian Foreign Exchange Market – An Analysis

Abstract

Forward exchange rate bias explanation generally falls into two categories – assumption of rational expectation resulting in a risk premium and expectation errors which is systematic. The paper tests the bias in the Indian forward exchange markets using one-month and three month forward contracts. The study finds that the three month contracts have larger prediction errors than the one-month contracts. The also paper finds that the prediction errors have information content which leads to assume the presence of risk premium. The study also finds that risk one-month contracts have lesser variability vis-à-vis the three month contracts.

Keywords: forward exchange rate, India, CCIL, bias, puzzle, exchange rate premium, exchange rate

JEL Classification: F31