An examination of the forward prediction error of U.S. dollar exchange rates and how they are related to bid-ask spreads,purchasing power parity disequilibria,and forward premium asymmetry |
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| Institution: | 1. The John B. and Lillian E. Neff Endowed Chair in Finance, The University of Toledo, 2801 W. Bancroft Street, Toledo, OH 43606, United States;2. Department of Finance and Economics, College of Business Administration, Georgia Southern University, Statesboro, GA 30460, United States;1. Department of Health Policy and Management, Jiann-Ping Hsu College of Public Health, Georgia Southern University, Statesboro, GA;2. Department of Health Services Research and Administration, College of Public Health, University of Nebraska Medical Center, Omaha, NE;1. Mechanical Engineering, Tufts University, 200 College Avenue, Medford, MA 02155, USA;2. Draper Laboratory, 555 Technology Square, Cambridge, MA 02139, USA;1. Department of Mathematics, University of South Carolina, Columbia, SC 29208, USA;2. Department of Mathematical Sciences, Georgia Southern University, Statesboro, GA 30460, USA |
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| Abstract: | Using a panel data approach, we find statistically significant evidence that bid-ask spreads and deviations from purchasing power parity (PPP) are related to the forward prediction error of ten major U.S. dollar exchange rates over the post Plaza Accord period. Previous literature suggests that bid-ask spreads proxy for liquidity risk and deviations from PPP are a source of time-varying risk premiums. Additionally, the paper provides evidence that the forward discount bias is asymmetric with respect to the sign of the forward premium as well as to an undervalued and overvalued U.S. dollar. |
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| Keywords: | Forward prediction error Liquidity risk Deviations from PPP |
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