We investigate the relation between foreign exchange (FX) order flow and the forward bias. We outline a decomposition of the forward bias according to which a negative correlation between interest rate differentials and order flow creates a time-varying risk premium consistent with that bias....

A sentiment-based model of the exchange rate is proposed to understand the forward premium puzzle. Agents over- or underestimate the growth rate of the economy. All else equal, when perceived domestic growth is higher than perceived foreign growth, the domestic interest rate is higher than the...

We jointly re-specify the relative purchasing power parity (RPPP) and uncovered interest rate parity (UIP) conditions as the (log) ratio of stochastic discount factors by inverting the market price of risk formula. Our empirical model provides new insights, which show that violations to UIP and...

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...

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...

In this paper we estimate risk-neutral probability density functions from EUR/HUF currency options using the Malz (1997) method. First, we compare different option-based indicators. We present so-called 'shortcut' indicators, i.e. indicators that can be calculated directly, without the...

This paper investigates the role of monetary policy in a small open economy, where exchange rate shocks are important. VAR models are estimated for the Czech Republic, Hungary and Poland. Contemporaneous and sign restrictions are imposed in order to identify the effect of monetary policy and...

We use futures instead of forward rates to study the complete maturity spectrum of the forward premium puzzle from two days to six months. At short maturities the slope coefficient is positive, but these turn negative as the maturity increases to the monthly level. Futures data allow us to...

Banking and balance of payments crises often happen quite simultaneously. We show that the impact of an expected devaluation on the net worth of commercial banks with a short open foreign exchange position speeds up the timing of a balance of payments crisis. We employ an asymmetric information...

This paper constructs an intertemporal model of the spot and forward markets for foreign exchange and shows that in equilibrium the forward market is unbiased, i.e., the forward rate is equal to the expected spot rate which will prevail in the market next period. This holds true as long as the...