Equilibrium adjustment, basis risk and risk transmission in spot and forward foreign exchange markets

Abstract

This study investigates the risk transmission between the spot and forward foreign exchange markets. In particular, the effect of innovation basis and signs of shocks in both markets are assessed. The market is less predictable when the spot and forward markets have experienced shocks of opposite signs. The spot market and the forward market are less predictable when both the spot and forward markets have experienced higher uncertainty in the previous periods, but the forward market is influenced more by the uncertainty of its own.

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