Are Indian Forward Spot Markets Rational Forecasts of Future Spot Rates

Abstract

The objective of the paper is to test the theory that forward spot markets are rational forecasts of future spot rates by studying data from Indian exchange markets over various forecast horizons ranging from one to twelve months. The time period is from August 2008 to 31 December 2013. The study found that there is high degree of correlation between the expected value of future spot rates calculated on the basis of Interest Rate Parity theory and the actual spot rate at the time of expiry of the derivative contract. The results of regression analysis shows that the actual spot rate at the time of expiry of the derivative contract is determined by the expected value of future spot rates, calculated on the basis of Interest Rate Parity theory. The empirical exercise also shows that the interest rate parity theorem helps in determining INR USD exchange rate (the future expected spot rate).