The forward premium puzzle: different tales from developed and emerging economies

In this paper we document new results regarding the forward premium puzzle. The often Found negative correlation between the expected currency depreci ation and interest rate differential is, contrary to popular belief, not a pervasive phenomenon. It is confined to developed economies, and here only to states where the U.S. interest rate exceeds foreign interest rates. Furt hermore, we find that differences across economies are systematically relat ed to per capita GNP, average inflation rates, and inflation volatility. Ou r empirical work suggests that it is hard to justify the cross-sectional di fferences in the risk premia as compensation for systematic risk. Instead, country-specific attributes seem to be important in characterizing the cros s-sectional dispersion in the risk premia. (C) 2000 Elsevier Science B.V. A ll rights reserved.