This paper tests the martingale hypothesis for daily data from the Deutschmark/US dollar futures and spot foreign exchange markets. Time-varying volatility of daily price changes is modelled as conditional heteroskedasticity which is a function of recent news or forecast errors, as in the ARCH model of Engle (1982). We find that the GARCH generalization of ARCH due to Bollerslev (1985) results in a very effective and parsimonious model. In both the futures and spot markets it provides a test equation which is not rejected. Apart from the relevance of the weekend effect, our test results support the martingale hypothesis for the Deutschmark/US dollar futures market.
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Paper provided by Queen's University, Department of Economics in its series Working Papers with number
639.