Abstract
We analyze the directional predictability in foreign exchange markets of Brazil, Russia, India, China and South Africa (BRICS) using the quantilogram, based on long-spans of monthly historical data, at times covering over a century. We find that the efficient market hypothesis (EMH) holds at the extreme phases of the currency markets (and around the median for India and South Africa). Since predictability holds at certain parts of the unconditional distribution of exchange rate returns, we find support for the Adaptive Market Hypothesis (AMH). AMH, based on the idea of bounded rationality, suggests that currency return predictability will be intermittent, due to changing market conditions and institutional factors.
Highlights
The efficient market hypothesis (EMH) states that asset prices fully and instantaneously reflect all available and relevant information (as discussed in Plakandaras et al, based on the seminal works of Samuelson, (1965) and Fama (1965)), returns cannot be predicted
The objective of this paper, is to analyze the directional predictability in foreign exchange markets of Brazil, Russia, India, China and South Africa using the correlogram of quantile hits as proposed by Linton and Whang (2007), which in turn, is a model-free econometric procedure involving a simple diagnostic statistic based on a sample correlation
The fact that predictability holds at certain parts of the unconditional distribution of exchange rate returns, capturing stages of the currency markets, our results tend to support the so-called adaptive market hypothesis (AMH) of Lo (2004, 2005)
Summary
The efficient market hypothesis (EMH) states that asset prices fully and instantaneously reflect all available and relevant information (as discussed in Plakandaras et al, (forthcoming), based on the seminal works of Samuelson, (1965) and Fama (1965)), returns cannot be predicted. Under the weak-form efficiency where the information set consists of past returns, future returns are purely unpredictable based on past price information. Return predictability can be related to the weak-form of market efficiency. In this regard, the associated literature that tests the EMH in financial markets is huge (see, Aye et al, (2017a, b), Charfeddine et al, (2018), and Tiwari et al, (forthcoming) for detailed literature reviews in this regard). The foreign exchange rate market in the most popular and capitalized market with an average daily turnover in 2016 of 5.1 trillion U.S dollars, as reported in the Triennial Survey of the Bank of International Settlements
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