THE EFFECT OF POLITICAL RISK ON THE FORWARD EXCHANGE BIAS - THE CASE OF ELECTIONS

The unsuccessful search for explanations of the forward bias has concentrated on variables suggested by traditional models of risk. Political news, although important to foreign exchange traders, has not been considered as a determinant of the forward bias. I present a model in which the forward bias changes when the governing party changes. Elections in major industrial countries provide a natural test of the model. The forward bias changed as predicted after half of the 13 elections in Canada, France, the United Kingdom, and the United States between 1973 and 1985. Politics provides useful information for foreign exchange traders which economists should not ignore.