Unbiased forward rate and time horizon in emerging economies and implications to hedging practices

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dc.contributor Aalto-yliopisto fi
dc.contributor Aalto University en
dc.contributor.author Varetsalo, Veli-Rasmus
dc.date.accessioned 2015-02-18T12:05:59Z
dc.date.available 2015-02-18T12:05:59Z
dc.date.issued 2014
dc.identifier.uri https://aaltodoc.aalto.fi/handle/123456789/15151
dc.description.abstract PURPOSE OF THE STUDY: The purpose of this study is to test the unbiased forward rate hypothesis in emerging economies and the impact of time horizon. The unbiased forward rate hypothesis tests whether a forward rate is an unbiased predictor of future exchange rate. The implications of findings on hedging foreign exchange risk are intended to be analyzed. DATA AND METHODOLOGY: The data consists of monthly observations of exchange rates and forward premiums for the maturities of 1-, 3-, 6- and 12-months for ten emerging economies: Brazil, Chile, Czech Republic, India, Indonesia, Mexico, Russia, South Africa, South Korea and Turkey. The exchange rate data is retrieved from Bloomberg terminal and all the quotes are against US dollar. For the aforementioned maturities, the unbiased forward rate hypothesis is tested with the Fama regression model using Newey-West standard errors. The time horizon effect for maturities of one and five years is examined by a graphical depiction of the forward prediction error in exchange rate terms. The five year forward premium is approximated by a sum of five consequent one year forward premiums. FINDINGS: On one month interval, the unbiased forward hypothesis is rejected in the emerging economies. Extending the time horizon to one year, the regression model produces increasingly biased estimates of future exchange rate. The graphical depiction of forward forecast error confirms the findings from the regression model. When comparing the one year bias to five year bias, measured in exchange rate terms, the bias is found to increase along with the extended time horizon. In the majority of the sample countries, on the five year maturity the forward prediction error becomes consistently positive implying that the five year forward rate is a systematically upwards biased predictor of future exchange rate. The impact on hedging performance depends on which currency the entity in question is selling and which currency it is buying with the forward contract. Hedging an emerging market currency denominated foreign exchange risk on a five year horizon has either been systematically profitable or unprofitable throughout the sample. en
dc.format.extent 75
dc.format.mimetype application/pdf en
dc.language.iso en en
dc.title Unbiased forward rate and time horizon in emerging economies and implications to hedging practices en
dc.type G2 Pro gradu, diplomityö fi
dc.contributor.school Kauppakorkeakoulu fi
dc.contributor.school School of Business en
dc.contributor.department Rahoituksen laitos fi
dc.contributor.department Department of Finance en
dc.subject.keyword Uncovered interest rate parity
dc.subject.keyword unbiased forward rate hypothesis
dc.subject.keyword time horizon effect
dc.subject.keyword emerging economies
dc.subject.keyword foreign exchange
dc.subject.keyword hedging
dc.subject.keyword OTC forward contract
dc.identifier.urn URN:NBN:fi:aalto-201502191856
dc.type.dcmitype text en
dc.programme.major Finance en
dc.programme.major Rahoitus fi
dc.type.ontasot Master's thesis en
dc.type.ontasot Pro gradu tutkielma fi
dc.subject.helecon rahoitus
dc.subject.helecon financing
dc.subject.helecon valuutta
dc.subject.helecon currency
dc.subject.helecon riskienhallinta
dc.subject.helecon risk management
dc.subject.helecon arvopaperimarkkinat
dc.subject.helecon stock exchange markets
dc.ethesisid 13810
dc.date.dateaccepted 2014-12-01
dc.location P1 I


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