The Risk Premium, Exchange Rate Expectations, and the Forward Exchange Rate: Estimates for the Yen–Dollar Rate

The hypothesis that the forward rate is an unbiased predictor of the future spot rate has been rejected in many empirical studies. The rejection of this hypothesis could occur because market behavior is inconsistent with rational–expectations or because there exists a risk premium. Equations describing the forward premium and the change in the exchange rate are estimated jointly, and tests of both the rational–expectations and no–risk–premium hypotheses are conducted. Empirical estimates, obtained using quarterly data for the yen–dollar exchange rate, reject the rational–expectations hypothesis and suggest that there exists a time–varying risk premium.