TITLE:
The Forward Exchange Rate Unbiasedness Hypothesis: A Single Break Unit Root and Cointegration Analysis
AUTHORS:
Michael E. Mazur, Miguel D. Ramirez
KEYWORDS:
Cointegration Analysis; Error-Correction Model (ECM); Forward Exchange Rate Unbiasedness Hypothesis (FRUH); KPSS No Unit Root Test; Unexploited Profits; Zivot-Andrews Single Break Unit Root Test
JOURNAL NAME:
Modern Economy,
Vol.4 No.9,
September
11,
2013
ABSTRACT:
In an
age of globalized finance, Forex market efficiency is particularly relevant as
agents engage in arbitrage opportunities across international markets. This study
tests the forward exchange rate unbiasedness hypothesis using more powerful
tests such as the Zivot-Andrews single-break unit root and the KPSS
stationarity (no unit root) tests to confirm that the USD/EUR spot and
three-month forward rates are I(1) in nature. The study successfully employs the
Engle-Granger cointegration analysis which identifies a stable long-run
relationship between the spot and forward rates and generates an ECM model that
is used to forecast the in-sample (historical) data. The study’s findings
refute past conclusions that fail to identify the data’s I(1) nature and
suggest that market efficiency is present in the long run but not necessarily
in the short run.