ME  Vol.4 No.9 , September 2013
The Forward Exchange Rate Unbiasedness Hypothesis: A Single Break Unit Root and Cointegration Analysis
ABSTRACT

In an age of globalized finance, Forex market efficiency is particularly relevant as agents engage in arbitrage opportunities across international markets. This study tests the forward exchange rate unbiasedness hypothesis using more powerful tests such as the Zivot-Andrews single-break unit root and the KPSS stationarity (no unit root) tests to confirm that the USD/EUR spot and three-month forward rates are I(1) in nature. The study successfully employs the Engle-Granger cointegration analysis which identifies a stable long-run relationship between the spot and forward rates and generates an ECM model that is used to forecast the in-sample (historical) data. The study’s findings refute past conclusions that fail to identify the data’s I(1) nature and suggest that market efficiency is present in the long run but not necessarily in the short run.


Cite this paper
M. Mazur and M. Ramirez, "The Forward Exchange Rate Unbiasedness Hypothesis: A Single Break Unit Root and Cointegration Analysis," Modern Economy, Vol. 4 No. 9, 2013, pp. 605-626. doi: 10.4236/me.2013.49066.
References
[1]   R. M. Levich, “Empirical Studies of Exchange Rates, Price Behavior, Rate Determination, and Market Efficiency,” In: R. W. Jones and P. B. Kennen, Eds., Handbook of International Economics, Vol. II, Elsevier, Amsterdam, 1978, pp. 979-1040.

[2]   J. A. Frenkel, “Flexible Exchange Rates, Prices, and the Role of News: Lessons from the 1970s,” In: R. A. Batchelor and G. E. Wood, Eds., Exchange Rate Policy, Macmillan, London, 1982.

[3]   R. E. Cumby and M. Obstfeld, “International Interest Rate and Price Level Linkages under Flexible Exchange Rates: A Review of the Evidence,” 1984.

[4]   C. Engel, “The Forward Discount Anomaly and the Risk Premium: A Survey of Recent Evidence,” Journal of Empirical Finance, Vol. 3, No. 2, 1996, pp. 123-192.

[5]   J. Olmo and K. Pilbeam, “Uncovered Interest Parity and the Efficiency of the Foreign Exchange Market: A Reexamination of the Evidence,” International Journal of Finance and Economics, Vol. 16, No. 2, 2011, pp. 189-204. doi:10.1002/ijfe.429

[6]   V. Ukpolo, “Exchange Rate Market Efficiency; Further Evidence from Cointegration Tests,” Applied Economics Letters, Vol. 2, No. 6, 1995, pp. 196-198. doi:10.1080/135048595357438

[7]   C. S. Hakkio and M. Rush, “Cointegration: How Short Is the Long Run?” Journal of International Money and Finance, Vol. 10, No. 4, 1991, pp. 571-581. doi:10.1016/0261-5606(91)90008-8

[8]   E. Zivot, “Cointegration and Forward and Spot Exchange Rate Regressions,” 1998. http://128.118.178.162/eps/em/papers/9812/9812001.pdf

[9]   M. Kuhl, “Cointegration in the Foreign Exchange Market and Market Efficiency since the Introduction of the Euro: Evidence Based on bivariate Cointegration Analyses,” 2007.

[10]   D. W. Duisenberg, “Recent Developments and Trends in World Financial Market,” 2000. http://www.ecb.int/press/key/date/2000/html/sp001114.en.html

[11]   A. C. Jung and V. Wieland, “Forward Rates and Spot Rates in the European Monetary System-Forward Market Efficiency,” Weltwirtschaftliches Archiv, Vol. 126, No. 4, 1990, pp. 615-629. doi:10.1007/BF02707471

[12]   E. Zivot and D. Andrews, “Further Evidence of Great Crash, the Oil Price Shock, and Unit Root Hypothesis,” Journal of Business and Economic Statistics, Vol. 10, No. 3, 1992, pp. 251-270. doi:10.1080/07350015.1992.10509904

[13]   D. Kwaitkowski, P. C. B. Phillips, P. Schmidt and Y. Shin, “Testing the Null Hypothesis of Stationarity against the Alternative of a Unit Root,” Journal of Econometrics, Vol. 54, No. 1-3, 1992, pp. 159-178. doi:10.1016/0304-4076(92)90104-Y

[14]   P. Perron, “The Great Crash, the Oil Price Shock and the Unit Root Hypothesis,” Econometrica, Vol. 57, No. 6, 1989, pp. 1361-1401. doi:10.2307/1913712

[15]   A. Seton, “On Unit Root Tests when the Alternative Is a Trend Break Stationary Process,” Journal Of Business and Economic Statistics, Vol. 21, No. 1, 2003, pp. 174-184. doi:10.1198/073500102288618874

[16]   W. K. Newey and K. West, “A Simple Positive Semi-Definite Heteroscedasticity and Autocorrelation Consistent Covariance Matrix,” Econometrica, Vol. 55, No. 3, 1987, pp. 703-708. doi:10.2307/1913610

[17]   H. Theil, “Applied Economic Forecasting,” North-Holland, Amsterdam, 1966.

 
 
Top