Empirical studies of market efficiency, liquidity effects and risk premiums in foreign exchange futures markets

Three main issues are addressed in this research. The first is how to incorporate the agents' risk averse behavior into the foreign exchange futures pricing forecasting model. The second concerns whether market liquidity has a significant effect on futures pricing and how to formulate its effect in a theoretically sound way. The third is to formulate a concept of basis risk which is bounded by the theoretical model and to test it. All these questions concern economic agents' decisions with regard to the exchange rate movements in foreign exchange markets. Our research formulated and tested the issues and our test results substantiated our prior expectations. In addition, these three issues are built upon the market efficiency hypothesis. So this too was tested.;The underlying theoretical structure that is employed is based on a mean-variance approaches of Muth (1961). The key extension made here is the incorporation of the market liquidity and interest volatility based on the term structure of interest rate.;The equilibrium futures pricing model is derived to test the efficiency of futures market in currencies. The results confirmed the efficiency of the foreign exchange futures market except for the Deutsche mark. By decomposing the risk premium between due to the expected interest change and due to the agent's behavior toward uncertainty, we succeeded in formulating and testing the basis risk premium and hedging risk premium.;The results of estimation can be interpreted as part of the evidence that the market efficiency and risk premiums could coexist under Keynes and Hicks' normal backwardation hypothesis. Surprisingly, the liquidity variables--transaction volume-- show very significant effects on futures pricing forecasting. Our findings show that the basis risk premium is more likely to be related to the economic fundamentals while the hedging risk premium is more likely associated with the agent's behavior toward risk. The incorporation of both the liquidity effects and the basis risk and the development of empirically tractable model would be our major contribution in this area.