The Forward Market in Emerging Currencies: Less Biased than in Major Currencies

Working Paper: NBER ID: w12496

Authors: Jeffrey Frankel; Jumana Poonawala

Abstract: any studies have replicated the finding that the forward rate is a biased predictor of the future change in the spot exchange rate. Usually the forward discount actually points in the wrong direction. But virtually all those studies apply to advanced economies and major currencies. We apply the same tests to a sample of 14 emerging market currencies. We find a smaller bias than for advanced country currencies. The coefficient is on average positive, i.e., the forward discount at least points in the right direction. It is never significantly less than zero. To us this suggests that a time-varying exchange risk premium may not be the explanation for traditional findings of bias. The reasoning is that emerging markets are probably riskier; yet we find that the bias in their forward rates is smaller. Emerging market currencies probably have more easily-identified trends of depreciation than currencies of advanced countries.

Keywords: No keywords provided

JEL Codes: F0; F15; F31

Causal Claims

Cause	Effect
higher perceived risks associated with emerging markets (F65)	forward exchange rates in emerging markets show less bias (F31)
bias remains present in emerging markets but is less severe (F65)	forward exchange rate is a less biased indicator for future expected spot rates in emerging economies (F31)
forward market in emerging currencies exhibits less bias than in major currencies (F31)	forward exchange rates in emerging markets are less biased predictors of future spot rates (F31)
average coefficient for emerging market currencies being positive (0.00033) (F31)	forward exchange rates in emerging markets are less biased predictors of future spot rates (F31)
coefficients for advanced economies are significantly negative (-4.3331) (C29)	forward exchange rates in advanced economies are more biased predictors of future spot rates (F31)