The Determinants of forward Premia in Indian Foreign Exchange Market

Abstract

Forward contracts play an important role in addressing exchange rate risk of the market participants viz., exporters, importers, overseas investors and borrowers in foreign currency. As more than 96% of India s newlineforeign exchange turnover is denominated in the USD, the present study focuses on determinants (quantitative and qualitative) of USD/INR forward rate during the period December 1998 through March 2011. newline newlineThe results of the study are found to be statistically robust and have policy implications. The results of Multiple Regression model suggest that Interest Rate Differential (IRD of MIBOR US LIBOR), Crude Price, Net Intervention of RBI, lagged values of forward premia, Turnover in the newlineforeign exchange market and IRD are the most significant variables in determining USD/INR forward premia. It is also found that REER, gross flows in Current and Capital Accounts of BoP and lagged value of RBI s Net Intervention are significant variables; but their impact on forward premia is found to be marginal . It is observed that USD/INR forward premia moved along with interest rate differential between 1999 and 2011 exhibiting growing level of integration in the markets. Further, it is noticed that the USD/INR forward premia witnessed sharp swings reflecting prevailing volatile market conditions during the study period.