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Forward Premiums and Market Efficiency: Panel Unit-root Evidence from the Term Structure of Forward Premiums

  • John T. Barkoulas

    ()

    (University of Tennessee)

  • Christopher F. Baum

    ()

    (Boston College
    DIW Berlin)

  • Atreya Chakraborty

    (University of Massachusetts-Boston)

A plausible explanation for cointegration among spot currency rates determined in efficient markets is the existence of a stationary, time-varying currency risk premium. Such an interpretation is contingent upon stationarity of the forward premium. However, empirical evidence on the stochastic properties of the forward premium series has been inconclusive. We apply a panel unit-root test--the Johansen likelihood ratio (JLR) test--to forward exchange premiums by utilizing cross-sectional information from their term structure. In contrast to earlier studies, the JLR test provides decisive and temporally stable evidence in support of stationary forward premiums, and therefore foreign exchange market efficiency, for six major currencies.

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Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 461.

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Length: 22 pages
Date of creation: 09 Jun 2000
Date of revision: 13 Jun 2001
Publication status: Published, Journal of Macroeconomics, 25(1), 109-122, 2003
Handle: RePEc:boc:bocoec:461
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  1. Pasaran, M.H. & Im, K.S. & Shin, Y., 1995. "Testing for Unit Roots in Heterogeneous Panels," Cambridge Working Papers in Economics 9526, Faculty of Economics, University of Cambridge.
  2. Karlsson, Sune & Löthgren, Mickael, 1999. "On the power and interpretation of panel unit root tests," SSE/EFI Working Paper Series in Economics and Finance 299, Stockholm School of Economics.
  3. Sarno, Lucio & Taylor, Mark P., 1998. "Real exchange rates under the recent float: unequivocal evidence of mean reversion," Economics Letters, Elsevier, vol. 60(2), pages 131-137, August.
  4. Dwyer, Gerald Jr. & Wallace, Myles S., 1992. "Cointegration and market efficiency," Journal of International Money and Finance, Elsevier, vol. 11(4), pages 318-327, August.
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  29. repec:cup:etheor:v:11:y:1995:i:5:p:984-1014 is not listed on IDEAS
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