Abstract
This study examines the efficiency of foreign exchange (forex) market of 10 selected countries in sub-Saharan Africa in the presence of structural break. It uses data on the average official exchange rate of currencies of the selected countries to the US dollar from November 1995 to October 2015. This study employs Perron unit root test with structural break to endogenously determine the break period in the forex markets. It also employs the Kim wild bootstrap variance ratio test and BDS independence test to detect linear and nonlinear dependence in forex market returns respectively. In the full sample period, the Kim wild bootstrap joint variance ratio test shows that only two forex markets are efficient while the BDS independence test reports that all the forex markets are not efficient. The subsample period analysis indicates that the efficiency of the majority of the forex markets is sensitive to structural break, thus providing evidence in support of the adaptive market hypothesis. This study suggests that ignoring structural break and nonlinearity of returns may lead to misleading results when testing for market efficiency.
Highlights
Investors in the foreign exchange market are concerned about the efficiency of the market in order to determine whether there is a possibility to outperform the market based on past market information. Meese and Rogoff (1983) pioneered research into the predictability of forex rate based on a random walk model.The ability to predict forex rate behaviour supports the assertion of the long-run purchasing power parity model
This study assessed the efficiency of the forex markets of 10 countries in sub-Saharan Africa in the presence of structural break
Using the Kim wild bootstrap joint variance ratio test, it can be observed that only the forex markets of Burundi and Ghana were efficient before and after the structural break and the forex markets of Gambia and Madagascar were not efficient prior to and after structural break
Summary
Investors in the foreign exchange (forex) market are concerned about the efficiency of the market in order to determine whether there is a possibility to outperform the market based on past market information. Meese and Rogoff (1983) pioneered research into the predictability of forex rate based on a random walk model. The RW2 model is appropriate when financial time series exhibits volatility Numerous studies such as Wright (2000), Belarie-Franch and Opong (2005), Yang, Su and Kolari (2008), Escanciano and Lobato (2009), Lazăr, Todea and Filip (2012), Charles, Darné and Kim (2012), Azar (2014), Salisu, Oloko and Oyewole (2016) tested for MDH rather than martingale hypothesis. Escanciano and Labato (2009) argue that it is easier to deal with returns because price tends to be non-stationary, making it common to test for MDH when testing the efficiency of the forex market. This study tests the forex market efficiency of 10 selected sub-Saharan African countries taking into account the presence of structural break in the markets. The rest of this study is outlined as follows: Section 2 deals with the literature review, Section 3 provides the data and preliminary analyses, and Section 4 and Section 5 present the empirical results and conclusion respectively
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