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Cointegration, Efficiency and Forecasting in the Currency Market

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  • Wilson H. S. Tong

Abstract

Existing literature on using the cointegration approach to examine the efficiency of the foreign exchange market gives mixed results. Arguments typically focus on econometric testing techniques, with fractional cointegration being the most current one. This paper tries to look at the issue from an economic perspective. It shows that the cointegrating relationship, whether cointegrated or fractionally cointegrated, is found mainly among the currencies of the European Monetary System which are set to fluctuate within a given range. Hence, there is no inconsistency with the notion of market efficiency. Yet, exploiting such a cointegrating relationship is helpful in currency forecasting. There is some evidence that restricting the forecasting model to consist of only cointegrated currencies improves forecasting efficiency.

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  • Wilson H. S. Tong, 2001. "Cointegration, Efficiency and Forecasting in the Currency Market," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 28(1‐2), pages 127-150, January.
    • Handle: RePEc:bla:jbfnac:v:28:y:2001:i:1-2:p:127-150
    DOI: 10.1111/1468-5957.00368
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