Random walk expectations and the forward discount puzzle
By: Philippe Bacchetta, Eric van Wincoop
Contributors: Van Wincoop, Eric; National Bureau of Economic Research
Series: NBER working paper series -- working paper 13205; Working paper series (National Bureau of Economic Research : Online) -- working paper no. 13205.
Publisher: National Bureau of Economic Research
Published: 2007
Place of publication: Cambridge, MA
Language: eng
Format: [electronic resource] /
Description: "Two well-known, but seemingly contradictory, features of exchange rates are that they are close to a random walk while at the same time exchange rate changes are predictable by interest rate differentials.  In this paper we investigate whether these two features of the data may in fact be related.  In particular, we ask whether the predictability of exchange rates by interest differentials naturally results when participants in the FX market adopt random walk expectations.  We find that random walk expectations can explain the forward discount puzzle, but only if FX portfolio positions are revised infrequently.  In contrast, with frequent portfolio adjustment and random walk expectations, we find that high interest rate currencies depreciate much more than what UIP would predict"--National Bureau of Economic Research web site.
Notes: Title from PDF file as viewed on 7/31/2007.

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