Suchergebnisse

In March this year, after a year in which policy appeared to be aimed at achieving stability against EMS currencies, the pound was allowed to rise sharply in response to large capital inflows. As with many fluctuations in exchange rates, this development was puzzling in that the prospects for the balance of payments suggested that the rise in sterling would not prove sustainable. On the other hand, high UK interest rates, particularly in relation to those available in EMS countries, provided some rationale for a temporary rise. This note uses a simple forward-looking equation for the exchange rate to illustrate the implications of alternative paths for interest rates and the balance of payments. A number of simulations are presented to illustrate the key elements of this approach.

Abstract
The bias of forward exchange rates as a predictor of future spot rates is typically explained or decomposed as (1) a risk premium and (2) a convexity term which accounts for the fact that, when there is stochastic inflation, nominal gains from forward currency speculation are higher than real ones and correspondingly losses are smaller. We use Nalebuff's envelope puzzle to explain a third source of bias which involves real profits from foreign exchange speculation. Both the "real profit" bias and stochastic inflation bias arise from convexity of g(s)=1/s and so derive from Jensen's inequality as observed by Siegel (1972).