ON THE BIASEDNESS OF FORWARD FOREIGN-EXCHANGE RATES - IRRATIONALITY OR RISK PREMIA

In this article we reconsider the Froot and Frankel results on the sources of forward discount bias. We question the economic validity of some estimation restrictions that they impose and, thus, are led to question some of their results. We employ a new exchange rate survey database that includes European Monetary System currencies and use univariate and pooling estimation techniques that impose fewer restrictions than those of Froot and Frankel to test our hypotheses. We find that the bias in the forward discount is attributable to both the failure of rational expectations and the existence of time-varying risk premia.