Citation

Discussion Paper Details

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Title: The Term Structure of Forward Exchange Premia and the Forecastability of Spot Exchange Rates: Correcting the Errors

Author(s): Richard Clarida and Mark P Taylor

Publication Date: June 1993

Keyword(s): Cointegration, Efficiency, Forecasting, Forward Exchange Rate, Information and Spot Exchange Rate

Programme Area(s): International Macroeconomics

Abstract: This paper challenges the widespread view that forward exchange premia contain little information regarding subsequent spot rate movements. Using weekly dollar/Deutschmark and dollar/sterling data, we show that spot and forward exchange rates are well represented by a vector error correction model and that the vector of forward premia form a basis for the cointegrating space. Dynamic forecasts indicate that the information in the forward premia can be used to reduce the root mean squared forecast error for the spot rate (relative to a random walk forecast) by at least 33% at a six-month horizon and by between 50% and 90% at a one-year horizon.

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Bibliographic Reference

Clarida, R and Taylor, M. 1993. 'The Term Structure of Forward Exchange Premia and the Forecastability of Spot Exchange Rates: Correcting the Errors'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=773