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The False Teachings of the Unbiased Expectations Hypothesis

2001; Euromoney Institutional Investor; Volume: 27; Issue: 4 Linguagem: Inglês

10.3905/jpm.2001.319816

2168-8656

Don M. Chance, Don R. Rich,

Market Dynamics and Volatility

The unbiased expectations hypothesis is the basis for many current investment strategies, despite its shortcomings. Yet the spot–forward parity theorem and the unbiased expectations hypothesis cannot both hold. Why do some in the investment community continue to believe that there is any more information in forward prices or rates than spot prices or rates? The authors show that forward prices have to be biased predictors of future spot prices, or arbitrage opportunities would arise. The bias is fair compensation for the difference in the timing of the cash flows between the spot and forward markets. The authors argue that the unbiased expectations hypothesis often forms the basis for trading strategies only because of the zero initial value and non–zero future value, the misuse of forwards in performance attribution, and a misunderstanding of the symmetry of risk premiums.