Understanding the Forward Premium Puzzle: A Microstructure Approach

By Craig Burnside, Martin Eichenbaum, Sergio Rebelo. 2009

144 citations recorded by the source corpus.

High-interest-rate currencies tend to appreciate relative to low-interest-rate currencies. We argue that adverse-selection problems between participants in foreign exchange markets can account for this 'forward premium puzzle.' The key feature of our model is that the adverse selection problem facing market makers is worse when, based on public information, a currency is expected to appreciate.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/0e83ba984cf3374958caaf49b2e86a3733d41130

Citations in the corpus

• Forward and Spot Exchange Rates in a Multi-Currency World* (2018, unknown): “See Tyron (1979), Hansen and Hodrick (1980), Bilson (1981), Meese and Rogoff (1983), Backus et al.”
• Safe Haven Currencies (2010, unknown): “1 See also Burnside, Eichenbaum, and Rebelo (2007b) , Burnside, Eichenbaum, Kleshchelski, and Rebelo (2008) and Lustig, Roussanov, and Verdelhan (2008).”
• Conditional Risk Premia in Currency Markets and Other Asset Classes (2014, unknown): “Burnside, Eichenbaum, Kleshchelski, and Rebelo (2011), Burnside, Eichenbaum, and Rebelo (2011, 2009), and Burnside, Han, Hirshleifer, and Wang (2011) focus on explanations of the carry trade such as investor overconfidence and peso problems.”
• The Forward Market in Emerging Currencies: Less Biased Than in Major Currencies (2010, unknown): “…and van Wincoop (2005), Backus, Foresi and Telmer (2002), Breuer (2000), Verschoor and Wolff (2001), Lustig and Verdelhan (2005), Verdelhan (2006), Lustig, Roussanov and Verdelhan (2008), Burnside, Eichenbaum, and Rebelo (2007), Gospodinov (2009), and Farhi and Gabaix (2008), among others.”
• Carry Trades and Global Foreign Exchange Volatility (2012, unknown): “…(2011) carefully document that carry trades are still profitable after covering most of the downside risk through the use of derivatives so that the puzzle basically remains, whereas Burnside, Eichenbaum, and Rebelo (2009) suggest that the forward premium may also be due to adverse selection risk.”
• Infrequent Portfolio Decisions: A Solution to the Forward Discount Puzzle (2010, unknown): “Therefore ct+1 = yt+1 + Mt Pt ~ mt et 1 Pt Pt+1 (19)”