On the Biasedness of Forward Foreign Exchange Rates: Irrationality of Risk Premia?

Posted: 11 Jan 1995

See all articles by Stefano Cavaglia

Stefano Cavaglia

Brinson Partners; Maastricht University - Department of Finance; PanAgora Asset Management, Inc.

Willem F. C. Verschoor

Vrije Universiteit Amsterdam, School of Business and Economics; Tinbergen Institute

Christian C. P. Wolff

University of Luxembourg; Centre for Economic Policy Research (CEPR)

Date Written: August 1994

Abstract

In this article we reconsider the Froot and Frankel (1989) results on the sources of forward discount bias. We question the economic validity of some estimation restrictions which they impose and, thus, are led to question some of their results. We employ a new exchange rate survey database that includes EMS currencies and use univariate and pooling estimation techniques that impose fewer restrictions than those of Froot and Frankel to test our hypotheses. We find that the bias in the forward discount is attributale to both the failure of rational expectations and the existence of time-varying risk premia.

JEL Classification: F31

Suggested Citation

Cavaglia, Stefano M. F. G. and Verschoor, Willem F. C. and Wolff, Christian C. P., On the Biasedness of Forward Foreign Exchange Rates: Irrationality of Risk Premia? (August 1994). Available at SSRN: https://ssrn.com/abstract=5743

Stefano M. F. G. Cavaglia (Contact Author)

Brinson Partners

209 LaSalle Street
Chicago, IL 60604
United States

Maastricht University - Department of Finance ( email )

Maastricht, 6200 MD
Netherlands
31 43 888-838 (Phone)
31 43 270-999 (Fax)

PanAgora Asset Management, Inc.

260 Franklin Street
22nd Floor
Boston, MA 02110
United States
617-439-6385 (Phone)

Willem F. C. Verschoor

Vrije Universiteit Amsterdam, School of Business and Economics ( email )

De Boelelaan 1105
Amsterdam, 1081 HV
Netherlands

Tinbergen Institute ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

Christian C. P. Wolff

University of Luxembourg ( email )

6, rue Richard Coudenhove-Kalergi
Kirchberg Campus
Luxembourg, South 1359
Luxembourg

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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