DP1090 Fixes: Of the Forward Discount Puzzle

Author(s): Robert P Flood, Andrew K Rose
Publication Date: December 1994
Keyword(s): EMS, Exchange Rates, Floating, Interest, Parity, Peso Problem, Uncovered
JEL(s): F31
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1090

Regressions of ex-post changes in floating exchange rates on appropriate interest differentials typically imply that the high interest rate currency tends to appreciate - the `forward discount puzzle'. Using data from the European Monetary System we find that a large part of the forward discount puzzle vanishes for regimes of fixed exchange rates. That is, deviations from uncovered interest parity appear to vary in a way that is dependent upon the exchange rate regime. By using the many EMS realignments we are also able to quantify the `peso problem'.