From Maynard and Phillips (2001) we quote: "The difference in persistence between the short-memory spot return and long-memory
forward premium does not admit a valid regression relation in returns and the slope coefficient in the Fama (1984) regression is found to converge to zero.
Behavioral Explanations for the
Forward Premium Puzzle
As a result, when a contract is renewed/rolled over during a volatility cluster, the risk due to higher volatility is often reflected in higher
forward premium, which makes hedging unattractive.
Forward premium anomaly refers to the empirical findings that changes in the spot exchange rate appear to be negatively correlated with the lagged
forward premium or discount.
and it is straightforward to show that the
forward premium is pinned down by the autocovariance properties of marginal utility, or equivalently by the covariance between the future short-term bond price and future marginal utility:
When we use the price changes for one quarter and include the
forward premium, the hedge fails the test in 5 of the 12 quarters.
The
forward premium, p, is defined as the difference between the expected and the forward price:
Figure 2 compares the
forward premium with the change in the spot rate, using weekly data.
Note that the
forward premium is obtained from the rolling premium by dividing both sides of the expression using [n1.
The
forward premium on a forward delivery bond is composed of two components, a liquidity premium and a forward rate premium.
On each rollover date the value of the contracts increases with the accumulation of the
forward premium (contango).
2] will measure the proportion of the variance of the
forward premium which is due to the variance of the risk premium and that of the expected change in spot rate, respectively.
