DP1090 | Fixes: Of the Forward Discount Puzzle

Publication Date

31/12/1994

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Abstract

Regressions of ex-post changes in floating exchange rates on appropriate interest differentials typically imply that the high interest rate currency tends to appreciate - the `forward discount puzzle'. Using data from the European Monetary System we find that a large part of the forward discount puzzle vanishes for regimes of fixed exchange rates. That is, deviations from uncovered interest parity appear to vary in a way that is dependent upon the exchange rate regime. By using the many EMS realignments we are also able to quantify the `peso problem'.