We are very grateful to Herman Bierens and Gerald Whitney for their comments and suggestions.
A new look at the forward premium “puzzle”†
Article first published online: 8 OCT 2010
© 2010 Wiley Periodicals, Inc.
Journal of Futures Markets
Volume 31, Issue 7, pages 599–628, July 2011
How to Cite
Al-Zoubi, H. A. (2011), A new look at the forward premium “puzzle”. J. Fut. Mark., 31: 599–628. doi: 10.1002/fut.20486
- Issue published online: 12 APR 2011
- Article first published online: 8 OCT 2010
- Manuscript Accepted: AUG 2010
- Manuscript Received: MAY 2010
We decompose the spot and forward rates into (permanent) nonlinear trend components and (transitory) stationary components. We examine the unbiasedness of the permanent (transitory) component of the forward rate in predicting the permanent (transitory) component of its corresponding future spot rate. The transitory component of the future spot rate under reacts to the transitory component of the forward rate. However, the permanent component of the forward rate is an unbiased predictor of the permanent component of the future spot rate. A robust nonlinear cotrending relation is also found between the forward and future spot rates and the hypothesis of the forward-rate unbiasedness is sustained in the long run. These results suggest that the forward rate better explains the long-term behavior of the future spot rate. Simulation analysis shows that if the transitory component of the forward rate fully predicts the transitory component of the future spot rate, the forward premium puzzle disappears. © 2010 Wiley Periodicals, Inc. Jrl Fut Mark 31:599–628, 2011