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American Economic Review Vol. 100 No. 3 2010

Infrequent Portfolio Decisions: A Solution to the Forward Discount Puzzle

Philippe Bacchetta1; Eric van Wincoop2

1 Faculty of Business and Economics, University of Lausanne, CH-1015 Lausanne, Switzerland and Swiss Finance Institute. · 2 Department of Economics, University of Virginia, P.O. Box 400182, Charlottesville, VA 22904-4182.

Abstract

A major puzzle in international finance is that high interest rate currencies tend to appreciate (forward discount puzzle). Motivated by the fact that only a small fraction of foreign currency holdings is actively managed, we calibrate a two-country model in which agents make infrequent portfolio decisions. We show that the model can account for the forward discount puzzle. It can also account for several related empirical phenomena, including that of “delayed overshooting.” We also show that making infrequent portfolio decisions is optimal as the welfare gain from active currency management is smaller than the corresponding fees.

DOI
10.1257/aer.100.3.870
Volume
100
Issue
3
Pages
870-904
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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