Understanding the forward premium puzzle: a microstructure approach

Burnside, C. , Eichenbaum, M. and Rebelo, S. (2009) Understanding the forward premium puzzle: a microstructure approach. American Economic Journal: Macroeconomics, 1(2), pp. 127-154. (doi:10.1257/mac.1.2.127)

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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.

Item Type:Articles
Status:Published
Refereed:Yes
Glasgow Author(s) Enlighten ID:Burnside, Professor Craig
Authors: Burnside, C., Eichenbaum, M., and Rebelo, S.
College/School:College of Social Sciences > Adam Smith Business School > Economics
Journal Name:American Economic Journal: Macroeconomics
ISSN:1945-7707
ISSN (Online):1945-7715

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