Abstract
With risk neutrality and no transaction costs, market efficiency reduces to the assertion that the forward rate is an unbiased forecast of the future spot exchange rate, i.e. that spot and lagged forward exchange rates are related by the cointegrating vector (0,1). This proposition is tested on daily data for the five major currencies using the Johansen multivariate cointegration methodology over the period 1976-1990. The data is examined for evidence of day-of-the-week and month-of-the-year seasonality. The evidence is mixed, but broadly supportive of the consensus view in the literature that currency markets and probably not efficient in this highly restrictive sense. Further results using the variance of the spot exchange rate as a measure of risk do little to reinstate efficiency.
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