Can structural changes in the persistence of the forward premium explain the forward premium anomaly?

Abstract

This paper investigates possible structural changes in the persistence of the forward premium by applying the multiple structural break methodology recently proposed by Kejriwal et al. (2013). The results reveal three or four breaks over the last three decades and provide evidence of long memory within each sub regime. The estimated break dates for the persistence appear to correspond to major economic events caused by macroeconomic shocks or changes in monetary policy. We provide some implications for the forward premium anomaly: if the forward premium is strictly stationary and has long memory, in which the confidence interval includes only the stationary region, the anomaly appears to be resolved or uncovered interest rate parity tends to hold. This finding suggests that the degree of the persistence of the forward premium plays an important role in explaining the anomaly. (C) 2018 Elsevier B.V. All rights reserved.