Abstract
The question of whether exchange rate markets are efficient or not, is directly related to whether or not long memory is pr esent in the exchange rate changes. Therefore, this paper explores the nature of the data generating processes of foreign exchange rate LKR against the US Dollar (USD), (LKR/USD) by examining the long memory properties of the LKR/USD return series based on econophysics models. In this study, autocorrelation function and spectral density function are used as visual test to inspect long memory of exchange rate returns. Further, parametric-ARFIMA model, Semi-parametric test proposed by Geweke and Porter-Hudak, Local Whittle estimator and non-parametric (R/S) test are employed as inferential tests to examine the long memory properties of the LKR/USD using daily data for the period from 2005-01-03 to 2016-12-30. Kernel density of LKR/USD return series show peak and fat tail postures. Visual inspection and inferential results reveal strong evidence of long memory property in the daily LKR/USD exchange rate return. It indicates that pricing by the market participants is not efficient. The results of this study have policy implications for traders and investors in designing and implementing trading strategies. It can also be helpful in predicting expected future return. Thus, the results of this study should be useful to regulators, practitioners and investors.
Highlights
In a globalized world, today, exchange rate plays a prominent role in international trade
Exchange rate changes defined as return series are having high volatility.Mean and variance of the LKR/US Dollar (USD) distribution change over time
Our results provide support for the hypothesis of longrange dependence in Sri Lankan exchange rates relative to the US dollar
Summary
Today, exchange rate plays a prominent role in international trade. The behavior of foreign exchange rates is of great importance to international investors. The nature of exchange rate dynamics is important for traders and investors in foreign currency markets. Understanding of long range dependence (long memory) of exchange rate return dynamics can be helpful in estimating expected return in designing, and implementing trading strategies. The study of the long memory property of exchange rate return is important for market participants.
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