NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

On Biases in the Measurement of Foreign Exchange Risk Premiums

Geert Bekaert, Robert J. Hodrick

NBER Working Paper No. 3861
Issued in October 1991
NBER Program(s):   ITI   AP   IFM

The hypothesis that the forward rate is an unbiased predictor of the future spot rate has been consistently rejected in recent empirical studies. This paper examines several sources of measurement error and misspecification that might induce biases in such studies. Although previous inferences are shown to be robust to a failure to construct true returns and to omitted variable bias arising from conditional heteroskedasticity in spot rates, we show that the parameters were not stable over the 1975-1989 sample period. Estimation that allows for endogenous regime shifts in the parameters demonstrates that deviations from unbiasedness were more severe in the 1980's.

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Document Object Identifier (DOI): 10.3386/w3861

Published: Journal of International Money and Finance, Vol.12, no.2 (April 1993): 115-138.

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