Abstract
High interest rate currencies tend to appreciate relative to low interest rate currencies. We argue that adverse selection problems between participants in foreign exchange markets can account for this "forward premium puzzle." The key feature of our model is that the adverse selection problem facing market makers is worse when an agent wants to trade against a public information signal. So, when based on public information, the currency is expected to appreciate, there is more adverse selection associated with a sell order than with a buy order.
Original language | English (US) |
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Pages (from-to) | 127-154 |
Number of pages | 28 |
Journal | American Economic Journal: Macroeconomics |
Volume | 1 |
Issue number | 2 |
DOIs | |
State | Published - Aug 1 2009 |
ASJC Scopus subject areas
- General Economics, Econometrics and Finance
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Replication data for: Understanding the Forward Premium Puzzle: A Microstructure Approach
Burnside, C. (Creator), Eichenbaum, M. (Creator) & Rebelo, S. (Creator), ICPSR - Interuniversity Consortium for Political and Social Research, 2009
DOI: 10.3886/e114042v1, https://www.openicpsr.org/openicpsr/project/114042/version/V1/view
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