Explaining Forward Exchange Bias…Intraday




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    • Haas School of Business Administration, U.C. Berkeley. We thank the following for helpful comments: an anonymous referee, Peter Garber, Richard Meese, and workshop participants at LSE and the University of Washington. We also thank the San Francisco Federal Reserve Bank for hospitality and assistance with data. Lyons gratefully acknowledges financial assistance from the National Science Foundation and the Berkeley Program in Finance.


Intraday interest rates are zero. Consequently, a foreign exchange dealer can short a vulnerable currency in the morning, close this position in the afternoon, and never face an interest cost. This tactic might seem especially attractive in times of fixed-rate crisis, since it suggests an immunity to the central bank's interest rate defense. In equilibrium, however, buyers of the vulnerable currency must be compensated on average with an intraday capital gain as long as no devaluation occurs. That is, currencies under attack should typically appreciate intraday. Using data on intraday exchange rate changes within the European Monetary System, we find this prediction is borne out.