Forward and spot exchange rates

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Abstract

There is a general consensus that forward exchange rates have little if any power as forecasts of future spot exchange rates. There is less agreement on whether forward rates contain time varying premiums. Conditional on the hypothesis that the forward market is efficient or rational, this paper finds that both components of forward rates vary through time. Moreover, most of the variation in forward rates is variation in premium, and the premium and expected future spot rate components of forward rates are negatively correlated.

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    The comments of John Bilson, David Hsieh, John Huizinga, Michael Mussa, Charles Plosser, Richard Roll, and Allan Stockman are gratefully acknowledged. This research is supported by the National Science Foundation.

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