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Cointegrating behaviour between spot and forward exchange rates

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  • David McMillan

Abstract

This paper re-considers cointegrating behaviour between forward and spot exchange rates and the implications for the forward rate unbiasedness hypothesis. Extant empirical evidence examining forward and future spot rates is mixed, offering results both for and against cointegration; the forward rate as an unbiased predictor of the spot rate; and the existence of a time-varying risk premium. However, recent research has suggested that such analysis may be subject to bias and that models of cointegration between forward and current spot rates should instead serve as a starting point for analysis of exchange rate behaviour. Johansen cointegration analysis supports this contention showing that erroneous inferences can be made by merely using future spot rate data. Subsequently both single equation and panel estimation methods support cointegration between forward and current spot rates, but that the forward rate is a biased predictor. Further, single equation tests are conducted over a rolling window of five years through our sample. These results largely confirm those for the full sample.

Suggested Citation

  • David McMillan, 2005. "Cointegrating behaviour between spot and forward exchange rates," Applied Financial Economics, Taylor & Francis Journals, vol. 15(16), pages 1135-1144.
    • Handle: RePEc:taf:apfiec:v:15:y:2005:i:16:p:1135-1144
    DOI: 10.1080/09603100500359476
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    References listed on IDEAS

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    Cited by:

    1. Samih Antoine Azar, 2018. "Forward Unbiasedness in the Short End of the Interest Rate Market," International Business Research, Canadian Center of Science and Education, vol. 11(2), pages 70-78, February.
    2. Abdulnasser Hatemi-J & Eduardo Roca, 2012. "A re-examination of the unbiased forward rate hypothesis in the presence of multiple unknown structural breaks," Applied Economics, Taylor & Francis Journals, vol. 44(11), pages 1443-1448, April.
    3. Fu, Hsuan & Luger, Richard, 2022. "Multiple testing of the forward rate unbiasedness hypothesis across currencies," Journal of Empirical Finance, Elsevier, vol. 68(C), pages 232-245.

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