The forward premium anomaly in currency markets (also referred to as the forward premium puzzle or the Fama puzzle) refers to the well documented empirical finding that the domestic currency appreciates when domestic nominal interest rates exceed foreign interest rates.
This is why some perceived as puzzling because one hypothesis has been that expected future change in the exchange rate between two countries is equal to the interest-rate differentials between these two countries. The idea behind the hypothesis is that if all currencies are equally risky investors would demand higher interest rates on currencies expected to fall in value. See: Forward exchange rate# Unbiasedness hypothesis. Thus, appreciation of the domestic currency when domestic interest rates are greater than foreign interest rates is called an anomaly.
- ^Fama, Eugene (1984), “Forward and spot exchange rates”, Journal of Monetary Economics, 14 (3): 319–338, doi:10.1016/0304-3932(84)90046-1
Ofer Abarbanel is a 25 year securities lending broker and expert who has advised many Israeli regulators, among them the Israel Tax Authority, with respect to stock loans, repurchase agreements and credit derivatives. Founder TBIL.co STATX Fund.