Market efficiency and cointegration: an application to the sterling and deutschemark exchange markets

doi:10.1016/0261-5606(89)90015-6

Journal of International Money and Finance

Volume 8, Issue 1, March 1989, Pages 75-88

https://doi.org/10.1016/0261-5606(89)90015-6 Get rights and content

Abstract

The assumption that the foreign exchange market is efficient, that is, that agents are risk neutral and use all available information rationally so that the forward exchange rate is an unbiased predictor of the future spot rate, is a property often imposed in theoretical international macroeconomic models. Although a vast empirical literature has evolved to test market efficiency, we use recent developments in the theory of cointegration to provide new methods of testing several aspects of foreign exchange market efficiency. We ffind evidence inconsistent with market efficiency for both Germany and the United Kingdom.

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Citation Excerpt :
After taking the first-order differences, the first differenced series are tested for a unit root using the ADF, KPSS and ERS tests. The market efficiency theory by which the joint assumptions of no risk premium and the agent's rational use of available information are emphasized (Hakkio & Rush, 1989) requires that ai = 0 and bi = 1 in Eqs. (8), (9) and (10), where i = 1, 2, 3. If the bitcoin exchange rate is unbiased to the spot FX rate, specified in Eq. (8), Eq. (10) is meant to state that the current forward FX rate should also be an unbiased predictor of the future bitcoin exchange rate.
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^∗: Part of this paper waas written while Mark Rush was a visiting scholar at the Federal Reserve Bank of Kansas City and while Craig Hakkio was at the Council of Economic Advisers. We thank the Financial Institutions and Monetary Policy Research Center at the University of Florida for helping support this research. The comments from two anonymous referees made a major impact in clarifying and altering our serults; we gratefully acknowledge their help. The views expressed herein are solely those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of Kansas City, nor of the Federal Reserve System, nor the Council of Economic Edvisers.

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Market efficiency and cointegration: an application to the sterling and deutschemark exchange markets

Abstract

Economic Letters

Journal of Monetary Economics

Journal of International Money and Finance

Carnegie-Rochester Conference Series on Public Policy

The Message in Daily Exchange Rates: A Conditional Variance Tale

On Unit Roots and the Cointegratability of Daily Spot and Forward Exchange Rates

Testing Rational Expectations and Efficiency in the Foreign Exchange Market

Econometrica

The Speculative Efficiency Hypothesis

Journal of Business

Exchange Rate Expectations and Nominal Interest Rate Differentials: A Test of the Fisher Hypothesis

Journal of Finance

Some Long-Run Feattures of Dynamic Time Series Models

Economic Journal

Econometric Modeling of the Aggregate Time Series Relatinship Between Consumer's Expenditure and Income in the United Kingdom

Economic Journal

Distribution of the Estimates for Autoregressive Time Series with a Uniot Root

Journal of the American Statistical Association

Likelihood Ratio Satistics for Autoregressive Time Series with a Unit Root

Econometrica

Real Exchange Rates During the Gold Standard