The Behavior of Turkish Lira forward and Spot Foreign Exchange Rates

The purpose of this study is twofold; firstly, the behavior of Turkish lira (TRL) forward rates against US Dollar (USD) and Euro will be evaluated; whether the interest rate parity holds and the market participants quote the forward foreign exchange rates according to the interest rate differentials. It is also analyzed whether the forward foreign exchange rate coincides with the spot exchange rate at the relevant maturity. Secondly, the unbiased forward rate hypothesis (UFH) is tested by the use of regression method. The finding is that for TRL against USD and Euro, the forward rate is a biased predictor of the future spot rate. Going the same way with the previous researchers, the source of the bias is examined. The explanations set by early researchers for the finding of bias in the forward markets for different currencies have been generally based on two different sets of explanations. The first category of explanation maintains the assumption of rational expectations and interprets the systematic component of the forward market’s prediction errors as a risk premium. The second category attributes the systematic component of the forward rate’s prediction errors to expectation errors on the part of market participants that are themselves systematic.