The Forward Rate as a Predictor of the Future Spot Rate- A

A stochastic coefficient model is developed to examine the unbiased forward-rate hypothesis (UFH) using exchange rate behavior on both full-sample and subsample estimations. Under the UFH, the forward rate in forward exchange markets is considered an unbiased predictor of the future spot rate. Studi...

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Bibliographic Details
Published inJournal of money, credit and banking Vol. 20; no. 2; p. 212
Main Author Chiang, Thomas C
Format Journal Article
LanguageEnglish
Published Columbus Ohio State University Press 01.05.1988
Subjects
Econometrics
Foreign exchange rates
Forward exchange
Hypotheses
Rational expectations
Regression analysis
Statistical data
Stochastic models
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Summary:A stochastic coefficient model is developed to examine the unbiased forward-rate hypothesis (UFH) using exchange rate behavior on both full-sample and subsample estimations. Under the UFH, the forward rate in forward exchange markets is considered an unbiased predictor of the future spot rate. Studies by Edwards (1982, 1983), Kohlhagen (1975), Longworth (1981), and Cornell (1977) have supported the UFH. Most empirical tests of the UFH are based on full-sample estimations, which assume that the structure of the behavioral relation is constant over time. Results of a full-sample estimation confirm the UFH for 4 markets studied (Canadian dollar, French franc, German mark, and British pound). The results of the subsample using joint-rolling regressions reject the UFH in most cases. The accuracy of the exchange rate predictions is improved when information underlying the stochastic pattern of the estimated parameters is used in forecasting. Time-series factors should be incorporated into the exchange rate predictions.
ISSN:0022-2879
1538-4616