Forward Exchange Rates in Efficient Markets: The Effects of News and Changes in Monetary Policy Regimes
Mack Ott and Paul T.W.M. Veugelers investigate the extent to which errors in forward exchange rate predictions of future spot exchange rates have been influenced, on the one hand, by changes in interest and inflation rates and, on the other, by changes in the policy stance of the U.S. monetary authority. The authors find that changes in interest differentials explain a portion of forward rate forecast errors, especially during the period of U.S. monetary aggregate targeting, October 1979 to September 1982, and that changes in the U.S. monetary policy regime alter the risk premium in forward exchange rates. The significant divergencies between the forward and spot exchange rate relations under different U.S. monetary policy regimes suggest that credible goals for monetary policy may be as important as the mechanical details of that policy’s execution.