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Monetary policy regimes and the forward bias for foreign exchange

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Lafuente, Juan A and Pérez Sánchez, Rafaela María and Ruiz Andújar, Jesús (2016) Monetary policy regimes and the forward bias for foreign exchange. Journal of Economics and Business, 85 . pp. 13-28. ISSN 0148-6195

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Official URL: https://doi.org/10.1016/j.jeconbus.2016.02.005



Abstract

This paper provides a theoretical discussion of the forward premium anomaly. We reformulate the well-known Lucas (1982) model by allowing for the existence ofmonetarypolicy regimes. The monetary supply is viewed as having two stochastic components: (a) a persistent component that reflects the preferences of the central bank regarding the long-run money supply or inflation target, and (b) a transitory component that represents short-lived interventions. To generate agents’ forecasts, we consider two scenarios: (a) consumers can distinguish the permanent and the transitory components of the money supply (complete information), and (b) consumers face a signal-extraction problem to disentangle permanent and transitory components of the money supply (incomplete information). We simulate the model from a careful estimate of the parameters involved in the model. Numerical simulations reveal that, under complete information, forward unbiasedness cannot be rejected at conventionally significant levels. However, when learning about monetary policy is incorporated, the forward bias can be reproduced without artificially assuming an unreasonable degree of risk aversion.


Item Type:Article
Uncontrolled Keywords:Monetary policy; Regime shifts; Learning; Forward bias.
Subjects:Social sciences > Economics > Money
Social sciences > Economics > Finance
Social sciences > Economics > Macroeconomics
JEL:E43, F31, G14
ID Code:55592
Deposited On:04 Jun 2019 13:14
Last Modified:12 Nov 2019 11:31

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