Learning, Forward Premium Puzzle and Exchange Rate Fundamentals under Sticky Prices

Chakraborty (2007) provides a model of adaptive learning applied to a simple monetary model of exchange rate under flexible prices to generate results similar to forward premium puzzle. This paper redifines the model and empirically examines key model assumptions of structural break in the relationship between exchange rates and fundamentals and the non-stationarity of fundamentals under the alternative assumption of sticky prices. The results show that although there is stronger evidence of structural break, the fundamentals follow stationary processes.