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Non-Informative Tests of the Unbiased Forward Exchange Rate

Published online by Cambridge University Press:  06 April 2009

Scott W. Barnhart ,
Robert McNown  and
Myles S. Wallace
Scott W. Barnhart
Affiliation:
Department of Finance, Florida Atlantic University, 5353 Parkside Dr, Jupiter, FL 33458
Robert McNown
Affiliation:
Department of Economics, University of Colorado, Boulder, CO 80309
Myles S. Wallace
Affiliation:
Department of Economics, Clemson University, Clemson, SC 29634.
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Abstract

This paper reexamines a familiar but unsettling result in the foreign exchange literature: that the forward rate is not an unbiased predictor of the future spot rate. The paper outlines why some frequently used tests of unbiasedness are non-informative in the sense that they are incapable of correctly testing the hypothesis. Specifically, many of these tests are based on regressions that suffer from simultaneity bias, resulting in biased and inconsistent estimators. This is true whether the tests are conducted using stationary or non-stationary data. We demonstrate this point both analytically and with simulations. Tests of co-integration, which are not subject to the critique presented in the paper, generally fail to reject unbiasedness.

Information

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 34 , Issue 2 , June 1999 , pp. 265 - 291
Copyright
Copyright © School of Business Administration, University of Washington 1999

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