On the Biasedness of Forward Foreign Exchange Rates: Irrationality of Risk Premia?
Posted: 11 Jan 1995
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: Suggested Citation