The Dynamics and Stochastics of Currency Betas Based on the Unbiasedness Hypothesis in Foreign Exchange Markets

Abstract

This article examines the dynamic and stochastic behavior of the beta coefficient (to be referred to as the currency beta) of the unbiasedness hypothesis (UH) in foreign exchange markets. We argue that the dynamics and stochastics of currency betas can be attributed to the dynamic behavior of various macroeconomic variables from different sectors of an economy, in addition to the trend variable considered in previous research. Incorporating four macroeconomic variables from the financial, real, and external sectors into the currency betas of eight currencies (developed and emerging) under a logarithmic change specification used to test the UH, we attempt to simultaneously test the behavior of currency betas in terms of nonstationarity, shifts in the mean and variance, and randomness. The vast quantity of empirical tests and results strongly suggests that the changing characteristics of currency betas are readily apparent and have important implications for the reconciliation of the controversies surrounding the legitimacy of the UH, for government exchange rate policies, and for the forecasting of future spot rates, across the developed and emerging economies under study. We also find different tales from developed and developing countries (JEL F31, F37, F47, G15).

Are Indian Forward Spot Markets Rational Forecasts of Future Spot Rates

“…A great number of studies have also been devoted to testing the Unbiasedness hypothesis (Lin & Chen, 1998;Lin, 1999;Lin & Lin, 2000& Lin et al,2002 provide thorough reviews of this empirical literature. Many of the studies in this area have considered only one sample period, one time horizon (mostly one month), and one or more currencies, so that the rejection or acceptance of the Unbiasedness hypothesis may well depend on the sample periods, currencies, and time horizons under study (Lin, 1999).…”

The Forward Exchange Rate Bias Puzzle Is Persistent: Evidence from Stochastic and Nonparametric Cointegration Tests

“…The efficient markets hypothesis (EMH) suggests that if markets are efficient (in the sense that the expected rate of return to speculation in the forward exchange market will be zero (e.g., Geweke and Feige, 1979; Hansen and Hodrick, 1980)), then forward exchange rates fully reflect available information about investors' expectations of future spot rates, and thus forward rates should be unbiased forecasts of future spot rates (e.g., Levich, 1979; Lin, 1999; Lin, Lin, and Chen, 2002).…”

“…2 2 See Levich (1979), Kohlhagen (1979), Bilson (1981), Hsieh (1984), Gregory and McCurdy (1984), Cavaglia, Verschoor, and Wolff (1993), Naka and Whitney (1995), Bakshi and Naka (1997), Lin (1999), and Lin, Lin, and Chen (2002). …”

Currency forecasting based on an error components-seemingly unrelated nonlinear regression model

“…A great number of studies have appeared to investigate the efficiency of foreign exchange markets and test the so-called simple efficiency market (SEM) hypothesis. Some studies (e.g., Chiang, 1988;Edwards, 1983;Kohlhagen, 1979) have confirmed the SEM hypothesis, while some others (e.g., Chiang and Chiang, 1987;Fama, 1984;Giddy and Dufey, 1975;Hansen and Hodrick, 1980;Wolff, 1987a,b;Lin, 1999;Lin et al, 2002) have provided empirical evidence to reject it. Still others (e.g., Domowitz and Hakkio, 1985;Edwards, 1982) have obtained mixed results.…”

“…Still others (e.g., Domowitz and Hakkio, 1985;Edwards, 1982) have obtained mixed results. Mussa (1979Mussa ( , 1984 and Lin et al (2002) have summarized several empirical regularities concerning the behaviour of exchange rates and its relationships with certain macroeconomic variables under the regime of floating rates.…”