Affine term structure models and the forward premium anomaly

One of the most puzzling features of currency prices is the forward premium anomaly: the tendency for high interest rate currencies to appreciate. We characterize the anomaly in the context of affine models of the term struct ure of interest rates. In affine models, the anomaly requires either that s tate variables have asymmetric effects on state prices in different currenc ies or that nominal interest rates take on negative values with positive pr obability. We find the quantitative properties of either alternative to hav e important shortcomings.