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An analysis of the unbiased forward rate hypothesis in developed and emerging economies

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  • Phungo, Muka
  • Bonga-Bonga, Lumengo

Abstract

This study assesses whether the unbiased forward rate hypothesis (UFRH) holds in its strong or weak form in selected developed and emerging economies. Moreover, the paper assesses whether this hypothesis, or the relationship between the forward and spot exchange rates, is better specified by a linear or nonlinear model. The paper makes use of the smooth transition error correction model (STECM) to account for long-run relationship and asymmetric adjustment between the two exchange rates. The results of the empirical analysis show the possibility of nonlinear cointegration between the spot and forward exchange rates in a number of developed and emerging economies. In addition, the results reveal that the magnitude of the speed of adjustment to cancel arbitrage opportunities is higher in emerging than in developed markets. This occurs because the size of arbitrage profit is higher in emerging markets compared to developed markets

Suggested Citation

  • Phungo, Muka & Bonga-Bonga, Lumengo, 2019. "An analysis of the unbiased forward rate hypothesis in developed and emerging economies," MPRA Paper 92222, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:92222
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    File URL: https://mpra.ub.uni-muenchen.de/92222/1/MPRA_paper_92222.pdf
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    References listed on IDEAS

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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    forward market; spot market; exchange rate; unbiased forward rate hypothesis; smooth transition error correction model;
    All these keywords.

    JEL classification:

    • C50 - Mathematical and Quantitative Methods - - Econometric Modeling - - - General
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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