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

Author

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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

    as
    1. Tsung-Wu Ho & Wan-Shin Mo, 2016. "Testing the Persistence of the Forward Premium: Structural Changes or Misspecification?," Open Economies Review, Springer, vol. 27(1), pages 119-138, February.
    2. Frankel, Jeffrey & Poonawala, Jumana, 2010. "The forward market in emerging currencies: Less biased than in major currencies," Journal of International Money and Finance, Elsevier, vol. 29(3), pages 585-598, April.
    3. Hodrick, Robert J. & Srivastava, Sanjay, 1984. "An investigation of risk and return in forward foreign exchange," Journal of International Money and Finance, Elsevier, vol. 3(1), pages 5-29, April.
    4. Barnhart, Scott W. & Szakmary, Andrew C., 1991. "Testing the Unbiased Forward Rate Hypothesis: Evidence on Unit Roots, Co-Integration, and Stochastic Coefficients," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 26(02), pages 245-267, June.
    5. Phillips, Peter C. B. & McFarland, James W., 1997. "Forward exchange market unbiasedness: the case of the Australian dollar since 1984," Journal of International Money and Finance, Elsevier, vol. 16(6), pages 885-907, December.
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    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    forward market; spot market; exchange rate; unbiased forward rate hypothesis; smooth transition error correction model;

    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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