| This dissertation contains four related but independent studies concerning foreign exchange market efficiency. Chapter 1 provides a brief history of the post-1973 modern floating exchange rate era, and a review of the literature. In Chapter 2, I show that spot and forward exchange rates contain unit roots and are co-integrated; these results rule out the use of certain specifications which have been used in the literature to test simple efficiency. When appropriate specifications are used, simple efficiency is resoundingly rejected. In addition, stability tests reveal that foreign exchange markets are becoming increasingly inconsistent with simple efficiency with the passage of time.; In Chapter 3, I examine whether excess returns can be earned by a trading rule which exploits deviations from simple efficiency, and whether the Capital Asset Pricing Model (CAPM) can explain these excess returns. I find that such a trading rule is highly profitable, and that the CAPM cannot explain the excess returns it generates even when the possibility of a time-varying covariance with the market portfolio is taken into account.; In Chapter 4, I examine the simple efficiency of cross exchange rates, focusing particular attention on whether a key exchange rate stabilizing agreement, the European Monetary System (EMS), has had an effect on the simple efficiency of intra-EMS exchange rates. My findings indicate that the existence and/or operations of the EMS have moved the intra-EMS exchange rates into closer conformity with simple efficiency. These results can be interpreted as supportive of the existence of risk premia in foreign exchange markets.; In Chapter 5, I examine the relationship between intervention proxies constructed from central bank foreign exchange reserve holdings and forward premia. In order for intervention to be responsible for the breakdown of simple efficiency documented in Chapter 2, there must be econometric causality running from the forward premium to intervention. My findings indicate the absence of causality in either direction, or any contemporaneous correlation between these variables, for most of the currencies examined. These and other results indicate that the breakdown of simple efficiency cannot be attributed to central bank intervention. |
