Understanding the forward premium puzzle: A microstructure approach

Research output: Contribution to journalArticle

41 Scopus citations

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 languageEnglish (US)
Pages (from-to)127-154
Number of pages28
JournalAmerican Economic Journal: Macroeconomics
Volume1
Issue number2
DOIs
StatePublished - Aug 1 2009

ASJC Scopus subject areas

  • Economics, Econometrics and Finance(all)

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