Forward Rate as an Unbiased Predictor of the Future Spot Rate. Some forecasters believe that foreign exchange markets for the major floating by “unbiased predictor” in terms of how the forward rate performs in estimating future spot exchange rates. Do you think that the foreign exchange market is an unbiased indicator? Give examples to support you answer.
The foreign exchange market is a market where buying and selling of currencies take place. According to Ferreira, Moore, and Mukherjee (2016), traders forecast the future prices of currencies and make a sell or buy entry in order to make a profit. Typically, a rising currency is bought while a falling one is sold. On the other hand, selling a rising pair of currency or buying a falling pair leads to massive losses. There are numerous tools used to analyze the foreign exchange market and make a relatively accurate prediction of future currency prices. One of the future spot rate predictors, Forward rate, has been put into question by several studies. Specific studies argue that the indicator is biased while others oppose it.
The paper contends that forward rates are unbiased predictors of future spot rates because they reflect all the available information. As an example, a forward rate reflecting the interest rates of the US as rising due to the increased borrowing costs predicts a fall in the price of the US dollar against other currencies. Another research indicated that forward rates are unbiased because they are specified in an agreement. The agreement is a contractual obligation that must be honored by the contracting parties (Hassan& Mano, 2014). For instance, a British exporter contracting with Europe undertakes to sell 2million GBP in exchange for EUR at a forward rate of 1.35 EUR per GBP in three months. The exporter is obligated to deliver the 2million GBP regardless of the state of the exchange rate at that time.
Ferreira, A. L., Moore, M., & Mukherjee, S. (2016). Expectation Errors in the Foreign Exchange Market.
Hassan, T. A., & Mano, R. C. (2014). Forward and spot exchange rates in a multi-currency world (No. w20294). National Bureau of Economic Research.
by EssayRoyal, Dec. 8, 2019, 6:09 p.m.