Fractional Integration and Cointegration in the Japanese Exchange Rate Market

Abstract

There is widespread agreement that the logarithmic spot and forward exchange rates are both integrated of order one (I(1)) variables, so that their corresponding returns are I(0) stationary. In this article, we examine this hypothesis for the Japanese market by means of fractional integration techniques. The results show that, although fractional degrees of integration are plausible in some cases, the confidence intervals include the unit root in both series. The possibility of the two variables being fractionally cointegrated is also examined throughout the differenced series. The empirical evidence supports this hypothesis, implying that there is a long run equilibrium relationship between the Japanese spot and forward exchange rates, with deviations from equilibrium being highly persistent.