Speculative Efficiency Research Articles

Foreign Exchange Market Efficiency, Speculators, Arbitrageurs and International Capital Flows

The foreign exchange market efficiency hypothesis is the proposition that prices fully reflect information available to market participants, i.e. hedged interest-arbitrageurs and speculators, and there are no opportunities for the hedgers or the speculators to make super-normal profits, i.e. both speculative efficiency and arbitraging efficiency exist. Numerous previous studies have tested for speculative efficiency and arbitraging efficiency by testing the following two hypotheses respectively: (i) the forward discount is a good predictor of the change in the future spot rate (implying covered interest parity (CIP), uncovered interest parity and rational expectations - all hold) and (ii) the forward discount tends to be equal to the interest differential (implying that CIP holds). It will be shown in this study that the hypotheses (i) and (ii) are valid null hypotheses for speculative efficiency and arbitraging efficiency respectively only if the following two set of assumptions hold: (a) there is no risk premium and no transaction costs and (b) that expectations are unbiased, efficient, firmly held and identical across agents. Thus, underlying the hypotheses (i) and (ii) above is the joint hypothesis that both set of assumptions hold. The rejection of UIP or CIP would simply mean the rejection of this joint hypothesis and not market efficiency. This study also provides a simple rationale for Stein (1965) model in which the fulfilment of covered and uncovered interest parities is unnecessary for foreign exchange market efficiency, even without transaction costs, provided that economic agents hold different expectations concerning exchange and political risks. Using the data on the interest rates and the spot and forward exchange rates for six OECD countries, for the period January 1982-June 1996, this study shows that the forward discount is a very poor predictor of the rate of currency depreciation and that covered interest differential (interest differential minus forward discount) tends to have an opposite sign to and vary inversely with interest differential. These results are inconsistent not only with both the hypotheses of speculative efficiency (based on UIP) and arbitraging efficiency (based on CIP) but also with the Mundell-Flemming proposition concerning capital movements. However, once the role of un-hedged arbitrageurs is recognized, the above results would be perfectly consistent with the Mundell-Flemming proposition. The un-hedged arbitrageurs are speculators who happen to find that they derive greater profit from un-hedged investment in a country of which the interest differential is in favour than from selling that country's currency forward and the condition for the existence of these un-hedged arbitrageurs is that they individually face different transaction costs in their forward exchange dealings. Three reasons for the unexpected relationship between covered and uncovered interest differential are given. The first involves the over-reaction by the government to inflation in fixing the forward discount. The second involves the over-reaction by the speculators to the interest differential in predicting currency depreciation. The third involves the failure of the government to prevent interest rate differential from failing to keep pace with inflation differential. It is argued that the third reason is the most plausible.

Testing for foreign exchange market efficiency - a trivariate vector autoregressive approach

The speculative efficiency of the forward exchange market for the British pound, Canadian dollar, German mark, Japanese yen and Swiss franc is evaluated in this study. The conventional approach of selecting spot and one-forward exchange rates is extended towards spot and two-forward exchange rates to consider the interactions among exchange rates of different contracts of different maturities. The possible cointegration of three series forms an error correction mechanism. Thus Campbell and Shiller's (1987) bivariate vector autoregressive model is extended to a trivariate VAR (TVAR) based on the error correction mechanism. A Wald test (with and without considering heteroscedasticity) is finally performed to examine the validity of the cross-equation restrictions. The speculative efficient market is rejected for the forward exchange market for the five currencies under study.

A non‐linear model of the real US/UK exchange rate

This paper provides a framework for building and estimating non-linear real exchange rate models. The approach derives the stationary distribution from a continuous time error correction model and estimates this by MLE methods. The derived distribution exhibits a wide variety of distributional shapes including multimodality. The main result is that swings in the US/UK rate over the period 1973:3 to 1990:5 can be attributed to the distribution becoming bimodal with the rate switching between equilibria. By capturing these changes in the distribution, the non-linear model yields improvements over the random walk, the speculative efficiency model, and Hamilton's stochastic segmented trends model.

A non-linear model of the real US/UK exchange rate

This paper provides a framework for building and estimating non-linear real exchange rate models. The approach derives the stationary distribution from a continuous time error correction model and estimates this by MLE methods. The derived distribution exhibits a wide variety of distributional shapes including multimodality. The main result is that swings in the US/UK rate over the period 1973:3 to 1990:5 can be attributed to the distribution becoming bimodal with the rate switching between equilibria. By capturing these changes in the distribution, the non-linear model yields improvements over the random walk, the speculative efficiency model, and Hamilton's stochastic segmented trends model.

Bettor handicapping and market efficiency in greyhound parimutuel gambling

This paper evaluates the speculative efficiency of the parimutuel gambling market for greyhound racing. The efficiency tests consider the informational content of bettor handicapping data as well as the forecasts of professional handicappers and the aggregate market. Previous studies have failed to consider the wide range of performance data that are available for bettor handicapping activities. Two tests of efficiency are considered. The first test evaluates the in-sample explanatory power of the handicapper's forecasts and handicapping data relative to the aggregate market's forecasts, as indicated by the final odds. The second test compares simulated rates of return to hypothetical gambling obtained from ex ante finish forecasts to the efficient rates of return that are dictated by the track's commission. Significant speculative inefficiencies are revealed. The second test suggests the existence of above-normal returns to gambling from using conditional forecasts generated from bettor handicapping data.

A model of speculative efficiency with ‘news’ error components

This paper proposes a theoritical model to assess of ‘news’ on the spot-forward-exchange-rate relationship and thereby predicts of the impact of ‘news’on the exchange rate. Two types of ‘news’ are analysed: rational expectations type innovations and announcement effects form newspapers. By using historical data form a time period which includes the German hyperinflation of the early 1920s, an estimate from of the model is derived which is substantially simpler than the version requried using contemporary data. Preliminary results support the main theoretical predictions but also cast some doubt on a literal interpretation of the exchange rate model plus rational expectations.

Speculative efficiency and risk premium in the market for foreign exchange: In search of the true specification

I show that while the unbiasedness hypothesis does not hold for the Deutsche Mark/U.S. dollar exchange rate market during the period 1979–1986, a risk premium cannot be detected either. In light of this inconclusiveness regarding the true model specification of exchange rate movements, the Davidson and Mackinnon approach of selecting models from amongst non-nested models is used to show that a model with risk premium is closer to the true specification than a model that implies unbiasedness.

Speculative efficiency and foreign currency futures: A focus on selected countries in North America, Western Europe, and the Pacific

This study extends the investigation of speculative efficiency and unbiasedness in the forward foreign exchange market to the foreign currency futures market. Consistent with the normal backwardation/contango hypothesis, results show that futures rates are not unbiased forecasts of future spot rates. A trading rule based on these results reveals attractive speculative opportunities which appear too large to be cccounted for by risk aversion of investors.

MODELLING RISK IN THE INTERWAR FOREIGN EXCHANGE MARKET

There is now evidence to reject the speculative efficiency hypothesis for the 1920s float. This paper investigates whether the rejection may be due to risk aversion. Two models of the risk premium are fitted: the ARCH-in-mean model and the DYMIMIC (kalman filter) model. Some support is found for the reichsmark, but the results are not otherwise supportive of either model. Copyright 1990 by Scottish Economic Society.

The Efficiency of the Market for Bank Accepted Bills*

The speculative efficiency of the Sydney Futures Exchange's market in bank accepted bills is examined by considering if the futures price is an unbiased predictor of the subsequent spot price and if other publicly available information can improve on this predictor. Data spanning the period 1980(1) to 1986(5) are employed The results are adverse to the efficiency hypothesis in that the futures price in some cases is not an unbiased predictor and neither is it an optimal predictor.

Speculative Efficiency and the Exchange Rate: Some Evidence Since the Float

This paper considers whether the speculative efficiency hypothesis holds in the foreign exchange market since the floating of the Australian dollar in December 1983. For the post‐float period as a whole, the speculative efficiency hypothesis can be rejected in the 30‐day market but not in the 15‐day or 90‐day markets. Evidence of a structural change in the market in February 1985—the time of the first major depreciation ‐ was also found.

Returns to Individual Traders of Futures: Aggregate Results

By means of a data set previously unavailable for academic research, actual trading histories of individual futures traders are examined. With this more detailed data, the author is able to (1) test the risk/return hypothesis directly; (2) include a much larger segment of the market than before; and (3) use actual instead of hypothetical t rading strategies. It is shown that the commercial (hedging) traders are most profitable, while noncommercial (speculative) traders earn n egative or zero profits. Because speculators are not receiving reward s for the risks they willingly absorb, the theory of normal backwarda tion and its extension can be rejected. Copyright 1987 by University of Chicago Press.

Comparing exchange rate forecasting models: Accuracy versus profitability

In this paper we compare the rankings of alternative exchange rate forecasting models using two different evaluation criteria: forecast accuracy and profitability in forward market speculation. Either or both of these criteria may be useful to the practitioner depending on the forecasting application. We use both time-series and static and dynamic structural models to construct forecasts for the Canadian dollar/U.S. dollar and German mark/U.S. dollar exchange rates over the period 1976 :12–1984: 9. Our results confirm earlier findings that simple time-series models such as the random walk rank highest in forecast accuracy. The random walk also ranks high in terms of profitability for the German mark, but for the Canadian dollar the profitability rankings are quite different than the accuracy results. For both currencies we find that some models are very profitable in forward speculation, which is evidence against the speculative efficiency hypothesis but may be consistent with the existence of risk premia in foreign exchange markets.

The Speculative Efficiency Hypothesis: A Bivariate Analysis

Journal Article The Speculative Efficiency Hypothesis: A Bivariate Analysis Get access E. Levy, E. Levy University of Liverpool Search for other works by this author on: Oxford Academic Google Scholar A. R. Nobay A. R. Nobay University of Liverpool Search for other works by this author on: Oxford Academic Google Scholar The Economic Journal, Volume 96, Issue Supplement, 1 December 1986, Pages 109–121, https://doi.org/10.2307/2232974 Published: 01 December 1986

Covered Interest Parity and Speculative Efficiency: Some Empirical Evidence for Australia*

Two key relationships which feature prominently through out modern international monetary theory are: (i) covered interest parity and(ii) speculative efficiency of the foreign exchange market, i.e., the unbiasedness of the forward rate as a predictor of the spot rate. This paper presents some empirical evidence for these two hypotheses using Australian data over the period September 1974 to December 1981 during which the Australian dollar was essentially floating. Both quarterly and overlapping monthly data are used. The results obtained generally provide some support for the two hypotheses.

The "Speculative Efficiency" Hypothesis

The hypothesis that forward prices are the best unbiased forecast of future spot prices is often presented in the economic and financial analysis of futures markets. This paper considers the hypothesis independently of its implications for rational expectations or market and in order to stress this fact, the term efficiency is used to characterize the state envisaged under the hypothesis. If a market is subject to efficient speculation, the supply of speculative funds is infinitely elastic at the forward price that is equal to the expected future spot price. The expected future spot price is a market price determined as the solution to the underlying rational expectations macroeconomic model. Although the paper is primarily concerned with testing this hypothesis in the foreign exchange market, the methodology introduced in the paper is of general application to all futures markets.

The Efficiency of Speculation in Urban Land

This paper analyzes the effect of speculation in land at the urban periphery on resource allocation. A simple dynamic model of residential location is developed and its properties are analyzed both qualitatively and numerically. One finding is that social costs in a typical city are increased by about three to seven per cent as a result of speculative increases in the value of idle land. Appropriate tax policies are studied.

The Interest Rate Parity Theorem: A Reinterpretation

The Interest Rate Parity Theorem: A Reinterpretation