02177cas a2200253 a 4500 AALejournalIMF008075 230101c9999 xx r poo 0 0eng d 5.00 USD 9781451844672 1018-5941 BD-DhAAL BD-DhAAL Meredith, Guy. The Forward Premium Puzzle Revisited / Guy Meredith, Yue Ma. Washington, D.C. : International Monetary Fund, 2002. 1 online resource (39 pages) IMF Working Papers <strong>Off-Campus Access:</strong> No User ID or Password Required <strong>On-Campus Access:</strong> No User ID or Password Required Electronic access restricted to authorized BRAC University faculty, staff and students The forward premium is a notoriously poor predictor of exchange rate movements. This failure must reflect deviations from risk neutrality and/or rational expectations. In addition, a mechanism is needed that generates the appropriate correlation between the forward premium and shocks arising from risk premia or expectations errors. This paper extends McCallum (1994) to show how such a correlation can arise from the response of monetary policy to output and inflation, which are in turn affected by the exchange rate. The theoretical models considered all generate results that are consistent with the forward premium being a biased predictor of short-term exchange rate movements; the bias decreases, however, as the horizon of the exchange rate change lengthens. Another common feature of the models is that the true reduced-form equation for exchange rate changes contains variables other than the interest differential, providing a justification for "eclectic" relationships for forecasting exchange rates. The results, however, remain consistent with using uncovered interest parity as a building block for structural models. Mode of access: Internet Ma, Yue. IMF Working Papers; Working Paper ; No. 2002/028 Full text available on IMF http://elibrary.imf.org/view/journals/001/2002/028/001.2002.issue-028-en.xml IMF e-Library