Expectations theory of forward exchange rates

Expectations theory of forward exchange rates

A theory of foreign exchange rates that states that the expected future spot foreign exchange rate t periods from now equals the current t-period forward exchange rate.

Pure Expectations Theory

In foreign exchange, a theory that forward exchange rates for delivery at some future date are equal to the spot rates for that date. The theory only functions in the absence of a risk premium. Critics contend that the evidence shows that pure expectations do not occur in actual trading.
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The expectations theory of forward exchange rates maintains that the expected spot exchange rate t periods in the future equal the t-period forward rate, so the PPP must hold for every period of t in equilibrium:
Currency choices in valuation: an approach for emerging markets
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