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DP6399
Understanding the Forward Premium Puzzle: A Microstructure Approach
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Publication Date:
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July 2007
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Link to this Page:
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www.cepr.org/pubs/dps/DP6399.asp.asp
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High-interest-rate currencies tend to appreciate relative to low-interest-rate currencies. We argue that adverse-selection problems between participants in foreign exchange markets can account for this `forward premium puzzle.' The key feature of our model is that the adverse selection problem facing market makers is worse when, based on public information, a currency is expected to appreciate.
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