Forward Rate Bias over a Third of a Century

Just updated/cleaned and extended the survey and forward rate data used in Chinn and Frankel (2019) (discussed in this post). Here are preliminary results regard forward rate bias, both pre- and post-crisis.

Consider the regression:

st+3-st = α + β(ft,t+3 – st) + ut+3

Where st is the log spot rate at time t, ft,t+3 is the log forward rate at time t for a trade at time t+3. Then OLS estimates of β are illustrated below for the early period up to 2008M05 (starting in 1986M08 for advanced currencies except euro, and 2001M10 for others), and late period from 2008M09 to 2018M05 2017M09.

Figure 1: β estimates from pre-crisis (blue bar) and post-crisis (red bar), using 3 month ahead forward rates. Green line at value of 1, implied by unbiasedness hypothesis. Source: authors’ calculations.

Figure 2: β estimates from pre-crisis (blue bar) and post-crisis (red bar), using 3 month ahead forward rates. Green line at value of 1, implied by unbiasedness hypothesis. Source: authors’ calculations.

Notice that in Figure 1, focusing on advanced country currencies, slope coefficients are typically positive in the post-crisis period, while negative in the pre-. This result is consistent with the findings in BCFH (2018), discussed in these posts [1], [2], and at VoxEU, to the extent that covered interest parity holds.

In Figure 2, much more varied experiences are recorded for both pre- and post- crisis for emerging market currencies, suggesting that the advanced economy experiences are not generalizeable. In part, this might be due to covered interest parity not holding as a result of capital controls. Or, the relative importance of monetary vs. real shocks might be the culprit. These issues will be the subject of further research using this data set.


10 thoughts on “Forward Rate Bias over a Third of a Century

  1. Moses Herzog

    This is one of those posts, I have to digest some and let my brain metabolize the nutrients before I can comment on it intelligently or risk asking a question that’s already been answered inside the paper. However I can use this as an excuse to get Menzie to post this conversation again between Eugene Fama And Andrew Lo which is a very enjoyable watch. You will notice if you watch, that Eugene Fama has a very strong ego. Normally I don’t like these type of people. However in Mr. Fama’s case, we can kind of “stomach” his strong ego, because he does have some legit reasons to hold his chin up a little high in the air, as we have to give the guy, he IS pretty damned sharp.

    Also Mr Fama is kind of a “living legend” in the finance world, similar to Warren Buffett. We should kind of treasure these guys as they “walk amongst us” rather than appreciating them after they die. NO, he is not “god”, still, we can admire his intellectual talents and the gifts he has given the world.

  2. Moses Herzog

    You know one thought that enters my head, as relates to the last paragraph of your post—- George Soros was pretty much a master at currency trading yes?? If you gave him a shot of sodium pentothal, and asked Soros what causes the covered interest parity not holding, would he have an answer?? Something tells me, he might. I mean, it may seem “simpleton” on my part, and naive, but what could it hurt if no one has asked him before?? The man is getting older and more out of it. He may actually know—- or at least have some very good hints, on the proper path of inquiry (“inquiry” read here as future research).

  3. Moses Herzog

    If anyone here has any thoughts (from German papers or otherwise) how these numbers add up to a 2nd referendum vote, I would love to hear them.

    This is in addition to another well respected politician saying there is basically no chance that there would be a referendum by the new Halloween “deadline”. Let’s say they do attempt to have a referendum before late October. Then you’re talking a very small window to sway public opinion, in a context in which there are more Brexit supporters than the 1st time they held the referendum. So you have 3 choices here.

    1) Go ahead and enact Brexit before the “self-imposed” May “deadline” (European elections).

    2) Have a 2nd referendum before late October, and most likely anti-Brexit get clobbered again, only even worse than the 1st referendum. Parliament and Britain embarrassed domestically and internationally twice.

    3) Have the Halloween “deadline” moved again, drag Brexit news obsession into 2020, anger many nations inside the EU, pray you can sway public opinion into being pro-EU by shoving in their face the message “you great unwashed didn’t vote how we ordered you to vote the first time, so we’re asking again so we can get the answer we want” All on the better than 50% chance, the voters still want Brexit.

    Now, if you’re a major political party, or a member of Parliament who wants to keep your slot—which one of those you wanna go with??? I guess it depends on how many times you enjoy hitting your head against a brick wall. Was once pain enough?? —-or you wanna try it 3 times and see if the third time you bash your head into the brick wall that alleviates the pain??

  4. JBH

    On the hermetically sealed minds on Econbrowser. Menzie Chinn and James Hamilton are to their great credit not amongst these. This topic is for them and the many followers of their generally excellent work who otherwise don’t comment.

    Much has changed on Econbrowser since the election of Donald Trump. For one, the ramped-up vitriol and divisiveness of the MSM has flooded over to the comments here. Secondly, the quality of comments has been greatly degraded by more than a handful of new posters who are self-proclaimed tyros yet flap their mouths incessantly. Or some who just because they are degreed in economics, think they know real-world economics but actually fall quite short. Were there inappropriate comments toward President Obama? Of course. But these were relatively few. Whereas the level of nastiness toward this president is a magnitude or more greater. There is no grace and there is no respect. His four predecessors each have huge blood on their hands from starting unnecessary wars. They took lives … and human life is the thing on this planet that is the most precious. Not only has this president not started a war, he has worked steadily toward disengaging the US from places we never should have been. Give him a break on the level of his testosterone, for God’s sake.

    It took a long time after Trump’s election for my thoughts around this to coalesce. Finally I have come to the conclusion that shockingly the belief systems of these posters are virtually impervious to nearly all information from the outside world that is not congruent with what they as a matter of faith believe (erroneously) that they already know. Of course the universe does not lie. It is where Truth resides. I and millions of others do exactly what Keynes said when the data changes. But the hermetically sealed minds here simply cannot. Nor do they realize they cannot!!! It is the extent of the hermetic sealedness of the minds here that is the shock. After much contemplation, and seeing how often some actually go so far as to dispute the very economic data that is right in front of their face (astonishing!), I can reach no other conclusion. If there is a rival conclusion with more merit, I’d surely like to hear it. The only other that I can think of is that they do know but do not let on.

    1. pgl

      Hermetically sealed minds? I guess your rant is based on the title “forward rate bias”. If it were – may we suggest you review the literature so you might figure out what a forward even is and in what context the term bias is being used. You’d then realize (we hope) that this rant does not have a single thing to do with this post.

    2. JBH

      Close to a tautology that the commenter whose mind is one of the most hermetically sealed here would – and you could count on it – sure enough be the one to denigrate my thought-provoking post. Clueless. Utterly clueless. Someone who is going through life unconscious. Agree with my post or disagree. Either is perfectly OK. But if you disagree, at least have something to say. This lone response was, however, vacuous. Vacuity being the hallmark of a mind stuck in the past because it is hermetically sealed. His reply could not have been a more perfect one to make my point.

    3. 2slugbaits

      JBH Hermetically sealed? Since I’m something of a fan of Habermas’ and (especially) Hannah Arendt’s epistemological approach to political theory, I think hermeneutically open would have been closer to the mark. OTOH, my inner positivist has a problem with sloppy econometrics and spurious regressions.

      Within the American political tradition Trump is a sui generis President. He’s also dangerous and utterly lacking any moral sense. He’s also dumb as a fencepost with the attention span of a goldfish. His Trump TV campaign rallies are incoherent stream-of-consciousness ramblings. His only worthwhile achievement was signing the bipartisan prison reform legislation. He deserves kudos for that. His tax plan was a mess that will eventually screw the very people who supported him the most. His trade policies are baffling. He counts success as a return to the status quo prior to his trade war. His two most recent Fed nominees are manifestly unqualified, but they flatter him and that’s all that matters. He surrounds himself that friends and family that cannot pass security background checks. Many of his appointees have a curious affection for swindlers and scammers. The reason Trump had to seek out Russian oligarchs is because no reputable US bank would do business with him because of his reputation for reneging on deals. He lies about everything. He lied about crowd size. He lied to foreign banks about the value of his properties. He lied to Forbes about his wealth. He lied about his academic history. He lied to his draft board. He lies to his wives. He says one thing one minute and then completely reverses himself faster than your remote can change channels away from Fox News. You’re right that he hasn’t (yet) started any new shooting wars, but he has escalated the shooting wars he inherited; e.g., Syria and Yemen. And he sure seems to be picking some shooting war fights with Venezuela and Iran. He trembles with fear when dealing with Putin or Xi or Kim; but bravely stands up to militarily weak countries like Venezuela, Cuba and Iran. The only people who are willing to work for him are the few total whack jobs that have no hope of finding any post-Trump employment, so they’re going along for the ride. People with real talent are bailing and don’t want to be contaminated by the Trump stink. And things are getting worse. When he first came to office he at least selected some folks who were minimally qualified; e.g., Jerome Powell. But lately his choices have been godawful.

      Like I said, I give him credit for prison reform. And if he comes through with a smart prescription drug plan I’ll give him credit for that. And if he puts together a solid infrastructure plan, then I’ll give him credit for that.

      Way back in college we read Clifford Geertz’ Princes and Peddlers. Lately Trumpism has reminded me a lot of that book. One of the cultures Geertz studied was a market economy but it lacked social trust and businesses depended upon family relationships rather than socially accepted norms. And this reliance upon close family relationships as a substitute for social trust was a major hindrance to economic development. I think that might be the long run legacy of Trumpism. He runs the country like a Mafia boss and has no regard for social trust. It’s all about scamming suckers and wolves eating the sheep. That was his approach to business and it’s his approach to politics. This won’t end well.

    1. Moses Herzog

      Don’t start up with your Nicole Kidman stories again. I’m pretty sure she was on the movie set of Billy Bathgate during the period in question.

  5. Zi Zi

    Ray Dalio wrote about his thoughts on US Capitalism and donated $100m.

    You should do what you can, for the US, for the Middle Class, directly.

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