Event Details

Solving the "Forward-Premium Puzzle" of Finance

https://www.imperial.ac.uk/people/k.m.abadir

University. His MA (Economics) and BA (Major in Economics, Minorin Business) are from AUC. He started his academic career as a lecturer inEconomics at Lincoln College, Oxford. He then joined the University of Exeteras a Senior Lecturer in Statistics and Econometrics, then Reader inEconometrics. He held the Chair of Econometrics and Statistics 1996-2005 at theUniversity of York, joint between the Departments of Mathematics and Economics,then the Chair of Financial Econometrics 2005-2017 at the Business School ofImperial College London. He is credited with having solved in his DPhil along-standing problem in Mathematical Statistics and Time Series that was opensince the 1950's. He also predicted the timing of the 2008 recession a year inadvance, and the different timings of the recoveries in various Westerncountries.

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The talk is based on work by myself and Gabriel Talmain: Solvingthe forward-premium puzzle.

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Macroeconomic and financial aggregate series have been shownempirically to share an unconventional form of cyclical and persistentdynamics, whose functional form was obtained from the solution ofgeneral-equilibrium models with heterogeneous firms (Abadir and Talmain, Reviewof Economic Studies 2002; Abadir, Caggiano, and Talmain, J Econometrics2013). Equations linking such series are modelled incompletely by existingtechniques, causing paradoxical regression results and omittingpredictabilities. We provide a solution to disentangle the genuine relationbetween variables from these dynamics and we apply it to modellingexchange-rate dynamics.

We show that GBPUSD forward premia have no predictive power forexcess returns (thus solving this forward-premium puzzle) once theunconventional dynamics of spot rates are modelled. Taking advantage of thesedynamics, we uncover a trading strategy that consistently outperforms existingones throughout 1977-2013. Hence, even in this heavily traded market, theEfficient Market Hypothesis has been failing for over 37 years because traderscould not work out the dynamics of the spot rate.