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Cointegration and Forward and Spot Exchange Rate Regressions

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Eric Zivot (University of Washington)

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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.

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Paper provided by EconWPA in its series Econometrics with number 9812001.

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Length: 36 pages
Date of creation: 22 Dec 1998
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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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Keywords: cointegration; exchange rates; forward rate unbiasedness; weak exogeneity;

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Find related papers by JEL classification:
C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions
F31 - International Economics - - International Finance - - - Foreign Exchange

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References listed on IDEAS
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Clinton Watkins & Michael McAleer, 2003. "Pricing of Non-ferrous Metals Futures on the London Metal Exchange," CIRJE F-Series CIRJE-F-213, CIRJE, Faculty of Economics, University of Tokyo. [Downloadable!]
    Other versions:
  2. Bams, Dennis & Walkowiak, Kim & Wolff, Christian C, 2003. "More Evidence on the Dollar Risk Premium in the Foreign Exchange Market," CEPR Discussion Papers 3726, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  3. Nikolaos Giannellis & Athanasios Papadopoulos, 2006. "Testing for Efficiency in Selected Developing Foreign Exchange Markets: An Equilibrium-based Approach," Working Papers 0717, University of Crete, Department of Economics. [Downloadable!]
    Other versions:
  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. [Downloadable!] (restricted)
    Other versions:
  5. Haitham A. Al-Zoubi & Dana A. Al-Zoubi & Aktham I. Maghyereh, 2006. "A nonparametric cointegration analysis of the forward rate unbiasedness hypothesis," Applied Financial Economics Letters, Taylor and Francis Journals, vol. 2(4), pages 223-227, July. [Downloadable!] (restricted)
  6. David G. McMillan, 2005. "Cointegrating behaviour between spot and forward exchange rates," Applied Financial Economics, Taylor and Francis Journals, vol. 15(16), pages 1135-1144, November. [Downloadable!] (restricted)
  7. 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. [Downloadable!]
  8. Stephen E. Haynes & Avik Chakraborty, 2005. "Econometrics of the forward premium puzzle," University of Oregon Economics Department Working Papers 2005-18, University of Oregon Economics Department. [Downloadable!]
  9. 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. [Downloadable!]
    Other versions:
  10. Young-Kyu Moh, 2006. "Continuous-time model of uncovered interest parity with regulated jump-diffusion interest differential," Applied Economics, Taylor and Francis Journals, vol. 38(21), pages 2523-2533, December. [Downloadable!] (restricted)
  11. 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. [Downloadable!] (restricted)
  12. 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. [Downloadable!] (restricted)
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