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  5. Infrequent Portfolio Decisions: A Solution to the Forward Discount Puzzle

American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

Infrequent Portfolio Decisions: A Solution to the Forward Discount Puzzle

  • Philippe Bacchetta
  • Eric van Wincoop
American Economic Review
vol. 100, no. 3, June 2010
(pp. 870–904)
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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. (JEL F31, G11, G15)

Citation

Bacchetta, Philippe, and Eric van Wincoop. 2010. "Infrequent Portfolio Decisions: A Solution to the Forward Discount Puzzle." American Economic Review, 100 (3): 870–904. DOI: 10.1257/aer.100.3.870

Additional Materials

JEL Classification

  • F31 Foreign Exchange
  • G11 Portfolio Choice; Investment Decisions
  • G15 International Financial Markets