Comment

Abstract

In this paper, Berge, Jordà, and Taylor significantly enhance our understanding of an important problem that has long occupied (plagued?) those studying international finance. About 30 years ago researchers began publishing evidence of systematic deviations from uncovered interest parity or, equivalently, of forward exchange rate bias. This raised an immediate set of questions. The first questions involved whether those results were a quirk of the sample period or the statistical tests employed. Over time it became apparent that the results were, in fact, robust. The more thorny questions involved what to make of the results. To what extent were the apparent deviations from uncovered interest parity or the corresponding apparent profits from the carry trade (which attempts to exploit deviations from uncovered interest parity by borrowing in low interest rate currencies and lending in high interest rate currencies) due to the absence or underrepresentation in the sample of large adverse events—the so-called peso problem—and to what extent were they real? And to the extent that they were real, did they reflect compensation for bearing risk or mispricing (inefficiency), or both? Those questions have proven to be perennial as well as thorny. Two surveys of this literature, Hodrick (1987) and Engel (1996), stand up extremely well to rereading today and contain excellent analytical descriptions of the accumulating evidence in the 10 or 15 years after the first evidence of a systematic forward bias emerged from the literature. Engel’s concluding paragraph (1996, 183) provides a summary of the state of knowledge at the time: “Progress in any scientific field is usually made in small increments. While Hodrick’s (1987) conclusion—‘We do not yet have a model of expected returns that fits the data’—is equally applicable today, progress has been made. What we have learned since 1987 is that many simple explanations for the forward exchange rate bias