Working Paper: CEPR ID: DP53
Authors: Charles R. Bean
Abstract: This note re-examines the results of tests of the hypothesis that the forward exchange rate is an unbiased and efficient predictor of the future spot exchange rate. As an alternative hypothesis we posit the existence of a time-varying risk premium. We show that it is possible to place a lower-bound on the variance of this term. The results suggest that for three out of the four bilateral rates examined new information explains less than half the variance of the difference between the forward rate and the realised future spot rate.
Keywords: exchange rates; efficient markets; risk premium
JEL Codes: 430
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| risk premium (G19) | forward exchange rate discrepancies (F31) |
| new information (D83) | forward exchange rate discrepancies (F31) |
| risk premium (G19) | exchange rate movements (F31) |
| new information (D83) | exchange rate movements (F31) |
| variance of risk premium (D81) | variance of exchange rate predictions (F31) |
| variance of new information (D89) | variance of exchange rate predictions (F31) |