Monetary policy and forward bias for foreign exchange revisited: Empirical evidence from the US-UK exchange rate

Forward exchange rate unbiasedness is rejected for international exchange markets. The two-country monetary model is extended to include an additional forward contract and a numerical solution method is proposed. Simulation exercises suggest that high uncertainty in monetary policy produces greater bias in the estimated slope coefficient in the regression of the change in the logarithm of the spot exchange rate on the forward premium. The model also suggests that the nature of the transmission between monetary shocks might explain the forward bias. Empirical evidence for the US-UK exchange rate according to our theoretical results is provided.