THE FOREIGN-EXCHANGE MARKET-EFFICIENCY HYPOTHESIS REVISITED

The foreign exchange market efficiency hypothesis is revisited using the modem Phillips-Hansen Fully Modified Ordinary Least squares (FM-OLS) procedure. It corrects for both endogeneity in the data and asymptotic bias in the coefficient estimates. The volatile decade of the 1980s is the chosen sample. The necessary and sufficient condition for market efficiency/unbiasedness is tested by sequentially conducting the Phillips-Ouliaris non-stationarity test on the residuals and the FM-WALD test for the required parameter values. Across the board evidence is found supporting cointegration between future spot rates and forward rates, i.e. the necessary condition is satisfied. But both the necessary and sufficient condition is supported for two out of four currencies, presumably due to the presence of the risk premium and/or market imperfections.