The Korean Economic Review
Monetary Policy Rules and the Forward Discount Bias
Min-Yong Shin / Tae Hwan YooYear 2006Vol. 22No. 2
Abstract
This is an attempt to explain forward discount bias in the foreign exchangemarket as influenced by monetary policy rules. A government response functionto external shocks is combined with the monetary model for exchange ratedetermination, and the risk premium is assumed to follow a first orderautoregressive process. The forward discount bias is more probable when thegovernment is concerned with interest rate or money supply stability than whenmonetary policy focuses on the stabilization of foreign exchange rate or pricelevel. These results are consistent with the experiences of ERM in the past –where forward discount bias is not found – and the survey results of Froot andThaler (1990).