Sarno, Lucio, Valente, Giorgio and Leon, H. L. (Hyginus Lambert) (2006) Nonlinearity in deviations from uncovered interest parity: an explanation of the forward bias puzzle. Discussion Paper. Centre for Economic Policy Research (Great Britain), London.

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Abstract

We provide empirical evidence that deviations from the uncovered interest rate parity (UIP) condition display significant nonlinearities, consistent with theories based on transactions costs or limits to speculation. This evidence suggests that the forward bias documented in the literature may be less indicative of major market inefficiencies than previously thought. Monte Carlo experiments allow us to reconcile these results with the large empirical literature on the forward bias puzzle since we show that, if the true process of UIP deviations were of the nonlinear form we consider, estimation of conventional spot-forward regressions would generate the anomalies documented in previous research.

Item Type:	Working or Discussion Paper (Discussion Paper)
Subjects:	H Social Sciences > HG Finance
Divisions:	Faculty of Social Sciences > Economics
Library of Congress Subject Headings (LCSH):	Interest rates, Foreign exchange futures, Foreign exchange rates, Nonlinear theories
Series Name:	Discussion paper (Centre for Economic Policy Research (Great Britain))
Publisher:	Centre for Economic Policy Research (Great Britain)
Place of Publication:	London
Date:	March 2006
Number:	No.552
Number of Pages:	49
Status:	Not Peer Reviewed
Access rights to Published version:	Open Access
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URI:	http://wrap.warwick.ac.uk/id/eprint/1715

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