Investor overconfidence and the forward premium puzzle
By: Craig Burnside, Bing Han, David Hirshleifer, Tracy Yue Wang
Contributors: National Bureau of Economic Research
Series: NBER working paper series -- working paper 15866; Working paper series (National Bureau of Economic Research : Online) -- working paper no. 15866.
Publisher: National Bureau of Economic Research
Published: 2010
Place of publication: Cambridge, MA
Language: eng
Format: Electronic resource
Description: "We offer an explanation for the forward premium puzzle in foreign exchange markets based upon investor overconfidence.  In the model, overconfident individuals overreact to their information about future inflation, which causes greater overshooting in the forward rate than in the spot rate.  Thus, when agents observe a signal of higher future inflation, the consequent rise in the forward premium predicts a subsequent downward correction of the spot rate.  The model can explain the magnitude of the forward premium bias and several other stylized facts related to the joint behavior of forward and spot exchange rates.  Our approach is also consistent with the availability of profitable carry trade strategies"--National Bureau of Economic Research web site.
Notes: Title from PDF file as viewed on 4/8/2010.

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