The information in the term structure

This paper presents a regression approach to measuring the information in forward interest rates about time varying premiums and future spot interest rates. Like earlier work, the regressions identify variation in the expected premiums on longer-maturity Treasury bills. The more novel evidence concerns the forecasts of future spot rates in forward rates. The regressions provide evidence that the one-month forward rate has power to predict the spot rate one month ahead. During periods preceding 1974, forward rates have reliable forecast power for one-month spot rates up to five months in the future.     

A VARIANCE DECOMPOSITION ANALYSIS OF THE INFORMATION IN THE TERM STRUCTURE

Based on a market efficiency assumption, we use variance decomposition analysis to separate information in the term structure on expected future spot rates from information on time-varying term premia and to examine the market's ability to forecast both future rate changes and excess returns on long versus short securities. We find that fluctuations in the slope of the yield curve are due more to changing term premia than to fluctuations in expected future spot rates and that the market correctly predicts about 40 percent of the month-to-month changes in spot rates, a considerably higher percentage than that found by previous studies.     

Do forecast errors or term premia really make the difference between long and short rates?

Forward rates in the term structure of interest contain predictions of future spot rates plus (possibly) term premia. Realized spot rates contain predicted spot rates plus forecast errors. Under rational expectations forecast errors are not predictable. By forecasting spot rates using publicly available information, bounds on the variation of forecast errors, and term premia are obtained. For one-month treasury bill rates, one to two thirds of the variation in the difference between forward rates and realized spot rates is due to variation in term premia.     

Spot and forward rates in the Canadian treasury bill market

The efficiency of the Canadian Treasury bill market is examined with data on spot and forward rates of return. Over the period from 7/62 to 3/79, the bill market has been efficient in the sense that it correctly uses the information contained in past spot rates in assessing the expected future spot rate and in determining the forward rate. Moreover, the forward rate is found to contain some information about future spot rates above and beyond that in past spot rates.     

The forward exchange rate and the prediction of the future spot rate: Empirical evidence

This paper examines the characteristics and evaluates the record of the forward exchange rate as a predictor of the future spot rate of three European currencies during the recent period of floating rates. The forward rate (for 1, 3 and 6 months) is compared to a simple predictor of ‘no change’ extrapolations (i.e., a Martingale model) by the use of Theil's inequality ratios. Theil's measures are then applied to assess the relative importance of the various sources of the forward's prediction errors, and the efficiency of the forecast is tested. The results show that the forward rate, while generally producing unbiased forecasts, fails to track the fluctuations in future spot rates and poorly reflects their variations. Further, it does not perform better than the current spot rate in predicting the future spot rate for all the examined forecast leads. Thus its usefulness for the purpose of business decisions is questioned.     

FORWARD RISK PREMIA AND THE MATURITY OF CONTRACTS: A NOTE

This paper examines the behavior of the risk premium component of currency forward rates. Analyzing forward rates of one, two and three-month maturity, we find that the power of forward rate as a predictor of future spot rate decreases with the length of contract maturity. Further, we find that the proportion of the variance of the forward premium which is due to the variation of the risk premium is larger than the proportion due to the expected spot rate change for all currencies except for the Canadian dollar. This proportion also increases with the length of maturity.     

Forward and spot exchange rates

There is a general consensus that forward exchange rates have little if any power as forecasts of future spot exchange rates. There is less agreement on whether forward rates contain time varying premiums. Conditional on the hypothesis that the forward market is efficient or rational, this paper finds that both components of forward rates vary through time. Moreover, most of the variation in forward rates is variation in premium, and the premium and expected future spot rate components of forward rates are negatively correlated.     

Expectations in the German hyperinflation reconsidered

Data on forward foreign exchange rates during the German hyperinflation after World War I provide direct observations of expected changes in the spot rate. Although levels of these forward rates seem to be efficient predictors of the spot rate, the predicted changes in the spot rate are biased downward substantially and do not meet the specific conditions of rationality. Indeed, the bias in the forward rate predictions is similar to bias in adaptive expectations of the spot rate. The behavior of the forward rate can be rationalized as a gradual market adaptation to a new regime of volatile and escalating inflation, reasonably represented by adaptive expectations. The strict definition of rational expectations needs to be broadened to allow for the difficulty of distinguishing between permanent and transitory shocks.     

The Forward Exchange Rate Bias Puzzle Is Persistent: Evidence from Stochastic and Nonparametric Cointegration Tests

An important puzzle in international finance is the failure of the forward exchange rate to be a rational forecast of the future spot rate. We document that even after accounting for nonstationarity, nonnormality, and heteroskedasticity using parametric and nonparametric tests on data for over a quarter century, U.S. dollar forward rates for the major currencies (the British pound, Japanese yen, Swiss franc, and the German mark) are generally not rational forecasts of future spot rates. These findings deepen the forward exchange rate bias puzzle, especially as these markets are the most liquid foreign exchange markets with very low trading costs.     

Forward rates as predictors of future spot rates

When adjusted for variation through time in expected premiums, the forward rates of interest that are implicit in Treasury Bill prices contain assessments of expected future spot rates of interest that are about as good as those that can be obtained from the information in past spot rates. Moreover, in setting bill prices and forward rates, the market reacts appropriately to the negative autocorrelation in monthly changes in the spot rate and to changes through time in the degree of this autocorrelation. This evidence is consistent with the market efficiency proposition that in setting bill prices, the market correctly uses the information in past spot rates.     

Estimating the Information Value of Immediate Disclosure of the FOMC Policy Directive

This paper studies the information value of immediate disclosure of the FOMC policy directive. The value of disclosure is measured by its ability to reduce investors' expected uncertainty about futures interest rates where uncertainty is defined as the conditional variance of forecast errors. Analytical relationships between new information and the conditional variance of forecast errors are developed and the relation of the “uncertainty-reducing” value of information to its social value, as defined in recent literature, is indicated. In the empirical work, forward interest rates are treated as reflecting market expectations conditioned on existing information. The empirical tests indicate that information in the undisclosed, prevailing policy directives (1974–79) were able to make only a very marginal improvement in the predictive accuracy of forecasts relying only on the forward rates. Thus, the hypothesis that immediate disclosure has a significant information value to market participants is not supported.     

THE RESPONSE OF FORWARD EXCHANGE RATES TO INTEREST RATE FORECASTING ERRORS

This paper examines the effects of interest rate news on changes in forward foreign exchange rates. Virtually none of the errors in forecasting forward exchange rates are explained by interest rate forecasting errors. The results are consistent with a conjecture that the forward exchange rate is not an estimate of the expected spot exchange rate.     

贸易谈判主导走势,双向波动特征明显——2019年人民币汇率走势回顾与展望

2019年人民币对美元即期汇率呈现先升后贬再升的“N”字型走势。中美贸易谈判进展继续主导人民币汇率波动;国际收支保持基本平衡,汇率对国际收支“调节器”作用显现;逆周期调节措施稳定市场预期,人民币境内外价差保持基本稳定。展望2020年,我国国际收支有望继续保持总体稳定、基本平衡的格局,预计中美贸易谈判进展情况将继续主导人民币汇率走势。     

Behavioural asymmetries in the G7 foreign exchange market

This paper examines the exchange rate disconnect puzzle of Obstfeld and Rogoff (2000) from a behavioural perspective. It provides evidence on the existence of substantial asymmetries in the underlying loss preferences for the difference between the spot and forward nominal exchange rates between the G7 countries for one-week and four-week forecast horizons. We further perform forecast breakdown tests in forward markets during the Greek and the Portuguese sovereign debt crisis, and then re-estimate the loss preferences showing a mean-reverting transition from optimism to pessimism and vice versa. Finally, we attribute the evolution of preferences to economic fundamentals and risk indexes and find that together with significant endogenous dynamics, variables such as growth and deficit differentials, interest rate and legal risk assert some significant impact on asymmetry. This new set of information suggests that the puzzle could have its roots on an underlying asymmetric loss function that reflects variability in preferences over exchange rate movements due to a variety of episodes in economic fundamentals.     

Forecasting currency prices using a genetically evolved neural network architecture

In this paper, a hybrid system combining neural networks and genetic training is designed to forecast the three-month spot rate of exchange for four currencies: the British pound, the German mark, the Japanese yen, and the Swiss franc. The networks' forecasts are compared to the predictions made by the forward and futures rates, and are evaluated based on their degree of accuracy and their ability to correctly forecast the direction of the change in the exchange rate movement.     

A Fractional Cointegration Approach to Testing Mean Reversion Between Spot and Forward Exchange Rates: A Case of High Frequency Data with Low Frequency Dynamics

This paper applies a relatively new but generalised concept of fractional cointegration to shed some light on the validity of a long-run relationship between high frequency daily spot and the lagged forward Australian-US dollar exchange rate. An investigation of the stochastic properties of these rates reveals that, while the relationship is not cointegrated in their logs, they appear to be fractionally cointegrated if we allow for mean reverting processes that are CI (1, d ) with 0< d <1. The paper demonstrates that relaxing the condition that the residual from the cointegration equation must be a I (0) process, captures a much wider class of mean-reversion behaviour. This result is interpreted in the context of the speculative EMH between the spot and forward exchanges rates, as having some empirical support. Furthermore, an analysis of the short-run dynamics propelling the long-run relationship tends to imply that in both the short- and long-term, the forward rate is led by the spot rate. In the longer term, the spot rate is found to be the initial receptor of any exogenous shock to the equilibrium and it is the forward exchange rate that bears the brunt of short-run adjustment to re-establish the long-run equilibrium relationship. The approach illustrated in this paper is shown to hold enormous potential for tests of mean reversion involving hypotheses popular to financial econometrics in general, where the dynamics of high frequency data are under scrutiny.     

Forward interest rate premium and asymmetric adjustment: Evidence from 16 countries

This paper examines the ability of the forward premium to provide an unbiased estimate of the future spot rate allowing for potential asymmetries. Extant evidence suggests that forward rates provide a biased predictor of future spot rates. Examining the forward premium for 16 countries, only for 2 countries does the linear expectations hypothesis holds. For the remaining countries, results generally support the view that the larger the forward premium the better a predictor for future spot rates it is, however, this result is not unique across all countries. Furthermore, although the asymmetric model improves data fit over the linear model, only in four cases does the model support an unbiased predictor interpretation. Further research is therefore required to understand the nature of this relationship, not least given the importance of correctly priced forward and long rates in terms of expected returns to future investments and the conduct of monetary policy.     

Cross‐sectional Restrictions on the Spot and Forward Term Structures of Interest Rates and Panel Unit Root Tests

In this paper we examine the stationarity of all the rates comprising the USD, GBP, DM and JPY spot and forward term structures. Instead of focussing on short maturity interest rates, as most other papers do, we perform a detailed analysis of the whole range of spot and forward interest rates of the 4 main currencies. We investigate the issue of stationarity within the framework of an equilibrium interest rate model such as Vasicek (1977), that defines the cross-sectional and time series properties that interest rates of various maturities must satisfy. We show that within a one-factor interest rate model, such as Vasicek, all interest rates are restricted to exhibit the same mean reverting behaviour. This restriction allows us to apply more powerful panel unit root tests. This methodology increases considerably the number of observations available and as a result the power of the unit root tests. The higher power of these tests allows us to demonstrate that there does exist mean reversion on the spot and forward US interest rates and the forward DM and GBP interest rates.     

The information in the Mexican term structure of interest rates: capital market implications

This paper employs the term structure approach to examine Mexican security markets during the recent period of political and economic turmoil. We investigate the characteristics of these markets and the forecast applicability of the pure expectations hypothesis to interest rates in Mexico. We find that both forward rates and spot rate spreads are found to have significant forecasting ability for future spot rates for Mexico. Both forecasting approaches suggest greater predictive ability during the period of higher interest rates and general economic volatility (1995–1996) than the more stable economic environment of the early 1990s (1991–1994).     

Structural change in the forward discount: Implications for the forward rate unbiasedness hypothesis

It is a well-accepted empirical result that forward exchange rate unbiasedness is rejected in tests using the “differences regression” of the change in the logarithm of the spot exchange rate on the forward discount. We model the forward discount as an AR(1) process and argue that its persistence is exaggerated due to the presence of structural breaks. We show using a stochastic multiple break model that the forward discount persistence is substantially less if one allows for multiple structural breaks in the mean of the process. We argue that these breaks could be identified as monetary shocks to the central bank's reaction function. Using Monte Carlo simulations, we show that if we do not account for structural breaks that are present in the forward discount process, the forward discount coefficient in the “differences regression” is severely biased downward, away from its true value of 1.