The term structure of the forward premium

Most studies of the efficiency of the foreign exchange market focus on a single maturity — usually a one month forward exchange rate. However, one observes that forward contracts of many maturities are simultaneously traded in the foreign exchange market. The hypothesis that the foreign exchange market uses all available information has implications for the joint behavior of forward exchange rates of various maturities. This paper proposes an equilibrium theory of the term structure of the forward premium. The model is tested using data on the German and Canadian exchange rates; the results indicate that the data are consistent with the theory for Germany and inconsistent with the theory for Canada.