The solution to the forward-bias puzzle: Reply

Possible solutions to the forward bias paradox

“…Furthermore the variance of the spot returns is often 20 times that of the forward premium. Contrary to the claim of Pippenger (2011), the recognition of this stylized fact dates back to Cornell (1977) and is mentioned by many subsequent authors. The other non standard aspect of Eq.…”

“…For all eight currencies the estimate of was indistinguishable from unity and the R 2 of the regression was 0.99. Given the CIP identity and hence restriction 1 + 3 = 0, it is clear that the regression estimated by Pippenger (2011) suffers from perfect multicollinearity. In fact the four regressions estimated by Pippenger in his Table 2, illustrate this very nicely.…”

“…Pippenger (2011) has claimed that the paradox disappears when two additional variables are admitted to the familiar forward premium regression. I argue that the "model" that Pippenger presents has nothing to do with the issues surrounding Uncovered Interest Parity (UIP).…”

“…In factPippenger (2011) continually underestimates the identity nature of the CIP condition. The properties of CIP were originally discussed byAliber (1973), while studies byAndersen and Bollerslev (1997) andLyons (2001) using extremely high frequency international finance data have…”

Pippenger's CIP-based solution to the forward-bias puzzle: A rejoinder

“…Pippenger's explanation for the forward-bias puzzle prompted several, largely critical, responses (Baillie, 2011;Chang, 2011;King, 2011;Müller, 2011) to which he has recently replied (Pippenger, 2011b). However, his defence of his model does not rebut the substance of the points raised against it.…”