Working Paper: NBER ID: w9391
Authors: Pierre-Olivier Gourinchas; Aaron Tornell
Abstract: We propose a new explanation for the forward-premium and the delayed-overshooting puzzles. Both puzzles arise from a systematic under-reaction of short-term interest rate forecasts to current innovations. Accordingly, the forward premium is always a biased predictor of future depreciation; the bias can be so severe as to lead to negative coeffcients in the 'Fama' regression; delayed overshooting may or may not occur depending upon the persistence of interest rate innovations and the degree of under-reaction; lastly, for G-7 countries against the U.S., these puzzles can be rationalized for values of the model's parameters that match empirical estimates
Keywords: No keywords provided
JEL Codes: E4; F31; G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| systematic underreaction of short-term interest rate forecasts to current innovations (E47) | biased forward premium (G41) |
| biased forward premium (G41) | future depreciation (D25) |
| increase in domestic interest rates relative to constant foreign short rates (E43) | exchange rate initially appreciates (F31) |
| misperceptions about the nature of the shock (E71) | gradual appreciation of the currency followed by depreciation (F31) |
| forward premium (G13) | negatively correlated with expected appreciation (G19) |
| misperception of the persistence of interest rate shocks (E43) | negative coefficients in the Fama regression (C29) |
| existence of predictable excess returns vanishes at long horizons (G14) | temporal aspect to causal claims (C41) |