DP15817 How Puzzling Is the Forward Premium Puzzle? A Meta-Analysis

Author(s): Tomas Havranek, Zuzana Irsova, Jiri Novak, Diana Zigraiova
Publication Date: February 2021
Keyword(s): Forward Rate Bias, meta-analysis, Model uncertainty, Publication bias, uncovered interest parity
JEL(s): C83, F31, G14
Programme Areas: International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15817

A key theoretical prediction in financial economics is that under risk neutrality and rational expectations a currency's forward rates should form unbiased predictors of future spot rates. Yet scores of empirical studies report negative slope coefficients from regressions of spot rates on forward rates. We collect 3,643 estimates from 91 research articles and using recently developed techniques investigate the effect of publication and misspecification biases on the reported results. Correcting for these biases yields slope coefficients in the intervals (0.23,0.45) and (0.95,1.16) for the currencies of developed and emerging countries respectively, which implies that empirical evidence is in line with the theoretical prediction for emerging economies and less puzzling than commonly thought for developed economies. Our results also suggest that the coefficients are systematically influenced by the choice of data, numeraire currency, and estimation method.