Behavioral Biases in Forward Rates as Forecasts of Future Exchange Rates: Evidence of Systematic Pessimism and Under-Reaction

Aggarwal, Raj; Zong, Sijing

Volume 12, Numbers 3 & 4 / September/December , Pages 157-312

Multinational Finance Journal, 2008, vol. 12, no. 3/4, pp. 241-277

Raj Aggarwal , University of Akron, U.S.A. Corresponding Author

Sijing Zong , California State University-Stanislaus, U.S.A.

Abstract:
Even though the forward-spot relationship in currency markets is very important for policy makers and for corporate and investment managers, it remains a theoretical and empirical puzzle. In theory the forward rate should be an unbiased forecast of the future spot rate, but this hypothesis has little empirical support. For the currencies of the nine major industrialized countries, this paper documents that in spite of the very high trading volumes in currency markets, consistent with evidence for other asset markets, revisions in the forward rate forecasts of the future spot exchange rate reflect systematic pessimism and under-reaction to new information.

Keywords : exchange rates; forward bias; market rationality; under-reaction
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