Exchange-Rate Return Predictability and the Adaptive Markets Hypothesis: Evidence from Major Foreign Exchange Rates

This study examines return predictability of major foreign exchange rates by testing for martingale difference hypothesis (MDH) using daily and weekly nominal exchange rates from 1975 to 2009. We use alternative MDH tests for linear and nonlinear dependence, which include wild bootstrap automatic variance ratio test, generalized spectral test, and consistent tests. We evaluate time-varying return predictability by applying these tests with fixed-length moving sub-sample windows of two years. While exchange rate returns are found to be unpredictable most of times, we do observe episodes of statistically significant return predictability. They are associated with coordinated central bank interventions and the subprime mortgage crisis in 2007. This finding suggests that return predictability of foreign exchange rates occurs from time to time depending on changing market conditions, which is consistent with the implications of the adaptive markets hypothesis.