The Effect of Errors in Variables on Tests for a Risk Premium in Forward Exchange Rates

  • Author(s): RODNEY L. JACOBS
  • Published: Apr 30, 2012
  • Pages: 667-677
  • DOI: 10.1111/j.1540-6261.1982.tb02216.x

ABSTRACT

Conventional tests for a risk premium in the price of forward exchange use the subsequently realized spot rate as a proxy for prior expectations. Use of this proxy creates a serious errors‐in‐variables problem which makes it difficult to reject the null hypothesis of zero risk premium. Use of a better proxy for expectations indicates the presence of a risk premium in the forward exchange rate of all countries analyzed.

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