The Forward Exchange Rate and the Interest Rate within a Production Economy

Abstract

This paper considers some equilibrium characteristics of the forward foreign exchange rate and the interest rate within a production economy. In order to derive the optimal solutions, a two-stage decision process is assumed; the first is the production decision, and the second is the portfolio decision. With some additional assumptions, both the forward exchange rate and the interest rate are shown to depend on the underlying stochastic parameter in the production function. Unlike in an exchange economy, the unbiasedness hypothesis of the forward exchange rate fails because of random technological shocks in production.