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Cointegration and Forward and Spot Exchange Rate Regressions

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  • Eric Zivot

    (University of Washington)

Abstract

In this paper we investigate in detail the relationship between models of cointegration between the current spot exchange rate, st, and the current forward rate, ft, and models of cointegration between the future spot rate, st+1, and ft and the implications of this relationship for tests of the forward rate unbiasedness hypothesis (FRUH). We argue that simple models of cointegration between st and ft more easily capture the stylized facts of typical exchange rate data than simple models of cointegration between st+1 and ft and so serve as a natural starting point for the analysis of exchange rate behavior. We show that simple models of cointegration between st and ft imply rather complicated models of cointegration between st+1 and ft. As a result, standard methods are often not appropriate for modeling the cointegrated behavior of (st+1, ft)' and we show that the use of such methods can lead to erroneous inferences regarding the FRUH.

Suggested Citation

  • Eric Zivot, 1998. "Cointegration and Forward and Spot Exchange Rate Regressions," Econometrics 9812001, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpem:9812001
    Note: Type of Document - Adobe Acrobat; prepared on IBM PC ; to print on N/A; pages: 36; figures: included
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    Cited by:

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    2. Giannellis, Nikolaos & Papadopoulos, Athanasios P., 2009. "Testing for efficiency in selected developing foreign exchange markets: An equilibrium-based approach," Economic Modelling, Elsevier, vol. 26(1), pages 155-166, January.
    3. Chinn, Menzie D. & Meredith, Guy, 2000. "Testing uncovered interest parity at short and long horizons," HWWA Discussion Papers 102, Hamburg Institute of International Economics (HWWA).
    4. Nelson Mark & Young-Kyu Moh, 2003. "Official Interventions and Occasional Violations of Uncovered Interest Party in the Dollar-DM Market," NBER Working Papers 9948, National Bureau of Economic Research, Inc.
    5. Neil Kellard & Paul Newbold & Tony Rayner, 2001. "Evaluating currency market efficiency: are cointegration tests appropriate?," Applied Financial Economics, Taylor & Francis Journals, vol. 11(6), pages 681-691.
    6. Wagner, Christian, 2012. "Risk-premia, carry-trade dynamics, and economic value of currency speculation," Journal of International Money and Finance, Elsevier, vol. 31(5), pages 1195-1219.
    7. Derek Bond & Michael J. Harrison & Niall Hession & Edward J. O'Brien, 2006. "Some Empirical Observations on the Forward Exchange Rate Anomaly," Trinity Economics Papers tep2006, Trinity College Dublin, Department of Economics.
    8. Chigira, Hiroaki, 2006. "A test of serial independence of deviations from cointegrating relations," Economics Letters, Elsevier, vol. 92(1), pages 52-57, July.
    9. Menzie D. Chinn & Guy Meredith, 2005. "Testing Uncovered Interest Parity at Short and Long Horizons during the Post-Bretton Woods Era," NBER Working Papers 11077, National Bureau of Economic Research, Inc.
    10. Clinton Watkins & Michael McAleer, 2006. "Pricing of non-ferrous metals futures on the London Metal Exchange," Applied Financial Economics, Taylor & Francis Journals, vol. 16(12), pages 853-880.
    11. Ali Kutan & Su Zhou, 2003. "Has the Link Between the Spot and Forward Exchange Rates Broken Down? Evidence from Rolling Cointegration Tests," Open Economies Review, Springer, vol. 14(4), pages 369-379, October.
    12. David McMillan, 2005. "Cointegrating behaviour between spot and forward exchange rates," Applied Financial Economics, Taylor & Francis Journals, vol. 15(16), pages 1135-1144.
    13. Bams, Dennis & Walkowiak, Kim & Wolff, Christian C. P., 2004. "More evidence on the dollar risk premium in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 23(2), pages 271-282, March.
    14. Sofiane Sekioua, 2004. "The forward unbiasedness hypothesis and the forward premium: a nonlinear analysis," Money Macro and Finance (MMF) Research Group Conference 2003 85, Money Macro and Finance Research Group.

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    More about this item

    Keywords

    cointegration; exchange rates; forward rate unbiasedness; weak exogeneity;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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