The forward rate unbiasedness hypothesis reexamined: evidence from a new test |
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Institution: | 1. Bursa Orhangazi University, Department of International Trade, 440 Mimar Sinan Mh. Ankara Yolu Cd., Bursa, Turkey;2. Boston University, Department of Electrical and Computer Engineering, 8 Saint Mary''s Street, Boston, Massachusetts 02215, USA;3. Aston University, Aston Business School, Operations & Information Management, Birmingham B4 7ET, UK;4. Peking University, China Center for Health Development Studies, 38 Xueyuan Rd, Beijing, China |
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Abstract: | Under conditions of risk neutrality and rational expectations in the foreign exchange market, there should be a one-to-one relationship between the forward rate and the corresponding future spot rate. However, cointegration-based tests of the unbiasedness hypothesis of the forward rate have produced mixed findings. In order to exploit significant cross-sectional dependencies, we test the unbiasedness hypothesis using a new multivariate (panel) unit-root test, the Johansen likelihood ratio (JLR) test, which offers important methodological advantages over alternative standard panel unit-root tests. When applied to a data set of eight major currencies in the post-Bretton Woods era, the JLR test provides strong and robust evidence in support of a unitary cointegrating vector between forward and corresponding future spot rates. However, the orthogonality condition is satisfied only for three major currencies. |
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