ON THE BIASEDNESS OF FORWARD FOREIGN-EXCHANGE RATES - IRRATIONALITY OR RISK PREMIA

In this article we reconsider the Froot and Frankel results on the sou rces of forward discount bias. We question the economic validity of so me estimation restrictions that they impose and, thus, are led to ques tion some of their results. We employ a new exchange rate survey datab ase that includes European Monetary System currencies and use univaria te and pooling estimation techniques that impose fewer restrictions th an those of Froot and Frankel to test our hypotheses. We find that the bias in the forward discount is attributable to both the failure of r ational expectations and the existence of time-varying risk premia.