The "forward premium puzzle" is the empirical regularity that low interest rates are not only associated with expected appreciation, but rather seem to be associated with expected depreciation across the major currencies with floating exchange rates. Although the first part of the puzzle would not be so surprising if there is a risk premium on one country's currency relative to another's, the second part would remain surprising.
In this paper it is shown that the second part would not be surprising if the risk premium is a deterministic trend rather than a stochastic variable as assumed in previous papers. It is also shown that Japanese low interest rate relative to US's has reflected a risk premium rather than expected appreciation, and that actual appreciation of Yen has been realized by unexpected factors.
