Regression vs. volatility tests of the efficiency of foreign exchange markets |
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| Affiliation: | 1. Portuguese Securities Market Commission, CMVM, Lisbon, Portugal;2. Department of Political Economics, ISCTE-Instituto Universitário de Lisboa, Lisbon, Portugal;3. Department of Quantitative Methods, ISCTE-Instituto Universitário de Lisboa, Business School, Lisbon, Portugal;2. MRC Integrative Epidemiology Unit, University of Bristol, Oakfield House, Oakfield Grove, Bristol BS8 2BN, UK |
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| Abstract: | Volatility tests are an alternative to regression tests for evaluating the joint null hypothesis of market efficiency and risk neutrality. By considering tests based on conditional volatility bounds, we show that if the alternative hypothesis is that one could ‘beat the market’ using a linear combination of observable variables, then regression tests are at least as powerful as the conditional volatility tests. If the application is to spot and forward markets for foreign exchange, then the most powerful conditional volatility test turns out to be equivalent to the analogous regression test in terms of asymptotic power. |
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