Skip to main content
eScholarship
Open Access Publications from the University of California

Exchange rate puzzles and distorted beliefs

  • Author(s): Gourinchas, P O
  • Tornell, A
  • et al.
Abstract

We propose a new explanation for the foreign exchange forward-premium and delayed-overshooting puzzles. We show that both puzzles arise from a systematic distortion in investors' beliefs about the interest rate process. Accordingly, the forward premium is always a biased predictor of future depreciation; the bias can be so severe as to lead to negative coefficients in the 'Fama' regression. Delayed overshooting may or may not occur depending upon the persistence of interest rate innovations and the degree of misperception. We document empirically the extent of this distortion using survey data for G-7 countries against the U.S. and find that it is strong enough to account for these irregularities. (C) 2004 Elsevier B.V. All rights reserved.

Many UC-authored scholarly publications are freely available on this site because of the UC Academic Senate's Open Access Policy. Let us know how this access is important for you.

Main Content
Current View