Abstract
FX market unbiasedness requires spot-forward cointegration with unitary vector, or a stationary forward-premium (FP). These conditions have found mixed support, which recent research explains via FP fractional integration. An alternative explanation is breaks in spot-forward cointegration regressions, so that I apply Gregory and Hansen [Gregory, A.W., Hansen, B.E., 1996a. Residual-based tests for cointegration in models with regime shifts. Journal of Econometrics 70, 99–126; 1996b. Tests for cointegration in models with regime and trend shifts. Oxford Bulletin of Economics and Statistics 58, 555–560] models to DM, Yen and Pound data, allowing for intercept, slope, and time-trend shifts. I adapt the procedure of Bai [Bai, J., 1997. Estimation of a change point in multiple regression models. Review of Economics and Statistics 79, 551–563] to sequentially search for multiple breaks, and find evidence of cointegration with “regime-and-trend shifts” for the three currencies. Cointegration-with-breaks regressions show stationary residuals and unitary slopes across regimes, consistent with long-run unbiasedness overall. Forward-premium regressions estimated for subsamples determined by cointegration-regression break dates find support for short-run unbiasedness in some regimes but not others.
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