The solution to the forward-bias puzzle

Although it has taken some 30 years to find, the solution to the forward-bias puzzle is straightforward. The standard test equation that produces the puzzle is missing two variables that covered interest parity implies should be included. For my data, those two missing variables explain the downward bias in the forward-bias puzzle. Covered interest parity also solves another closely related puzzle. The variance for changes in exchange rates is 100–200 times larger than the variance in forward premiums.