Understanding the Forward Premium Puzzle A Microstructure Approach, American Economic Journal: Macroeconomics
High-interest-rate currencies tend to appreciate relative to low-interest-rate currencies. We argue that adverse-selection problems between participants in foreign exchange markets can account for this forward premium puzzle. The key feature of our model is that the adverse selection problem facing market makers is worse when, based on public information, a currency is expected to appreciate.
Craig Burnside, Martin S. Eichenbaum, Sergio Rebelo
Burnside, Craig, Martin S. Eichenbaum, and Sergio Rebelo. 2009. Understanding the Forward Premium Puzzle A Microstructure Approach. American Economic Journal: Macroeconomics. 1(2): 127-154.