Abstract
This paper uses an efficiency specification model of the spot and forward foreign exchange markets and tests the hypotheses for random walk (which cannot be rejected), general efficiency, and unbiasedness by using a regression estimation and various specification and diagnostic tests for the series and the error terms (residuals). Whereas the forward rate is usually viewed as an unbiased predictor of the future spot rate, the unbiased forward rate hypothesis has failed to be rejected for the Canadian dollar, although more research is needed in this particular area so that better statistical inferences can be drawn in the future.
Highlights
Economic theorists posit that the forward exchange rate will be an unbiased predictor of the future spot rate whenever we have the condition of efficient markets coupled with rational expectations
All our models today assume that market efficiency exists; but does it exist? An understanding of market efficiency and any improvements in it are important to government policymakers, central bankers, managers of multinational corporations, and international investors
In this efficiency specification model of spot and forward exchange markets, we argued that the forward rate fully reflects the limited available information about exchange rate expectations and the forward rate because of the lack of complete and correct global knowledge or ‘wisdom.’ the forward rate is usually viewed by the market as an unbiased predictor of the future spot rate
Summary
Economic theorists posit that the forward exchange rate will be an unbiased predictor of the future spot rate whenever we have the condition of efficient markets coupled with rational expectations (i.e., correct on average). In addition to domestic finance, the efficiency hypothesis has been used in many foreign exchange market studies This hypothesis itself suggests that there are no unexploited profit opportunities and, in the foreign exchange market, implies that the forward rate summarizes all relevant and available information that could be used in a forecast of the future spot rate. Analyzing this aspect of efficiency requires an equilibrium model of pricing in the foreign exchange market. The section deals with the model’s different specifications and diagnostic testing, with the final section providing a summary and concluding remarks
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