Showing papers on "Forward exchange rate published in 1980"

Forward Exchange Rates as Optimal Predictors of Future Spot Rates: An Econometric Analysis

Abstract: This paper examines the hypothesis that the expected rate of return to speculation in the forward foreign exchange market is zero; that is, the logarithm of the forward exchange rate is the market's conditional expectation of the logarithm of the future spot rate. A new computationally tractable econometric methodology for examining restrictions on a k-step-ahead forecasting equation is employed. Using data sampled more finely than the forecast interval, we are able to reject the simple market efficiency hypothesis for exchange rates from the 1970s and the 1920s. For the modern experience, the tests are also inconsistent with several alternative hypotheses which typically characterize the relationship between spot and forward exchange rates.

The Forward Exchange Rate, Expectations, and the Demand for Money-The German Hyperinflation: Comment

Abstract: As Phillip Cagan pointed out, hyperinflation provides the opportunity to study monetary phenomena in a situation where increases in nominal quantities dwarf changes in real quantities. The large changes in prices, moreover, surely create sizeable incentives to predict as well as possible the changes in these prices. Thus a central feature of a model of asset supply and demand in hyperinflation is the way in which agents are assumed to form their expectations. In a recent article in this Review, Jacob Frenkel proposed to infer from the data on spot and forward deutsche mark exchange the onemonth future rate of inflation expected in Germany during the post-World War I hyperinflation. The major virtue of such an approach, suggested Frenkel, was that it depended on observable market prices rather than mechanistic formulae to generate agents' guesses as to the opportunity cost of holding money. Frenkel based his conclusion that foreign exchange data could be used to measure inflation expectations on evidence that during the hyperinflation the market in deutsche mark exchange functioned efficiently. He based his conclusion that exchange markets were efficient on his estimates of two regressions:

Expectations and the Forward Exchange Rate

Abstract: This paper provides an empirical examination of the hypothesis that the forward exchange rate provides an "optimal" forecast of the future spot ex-change rate, for five currencies relative to the dollar. This hypothesis provides a convenient norm for examining the erratic behavior of exchange rates; this erratic behavior represents an efficient market that is quickly incorporating new information into the current exchange rate. This hypothesis is analyzed using two distinct, but related, approaches. The first approach is based on a regression of spot rates on lagged forward rates. When using weekly data and a one month forward exchange rate, ordinary least squares regression analysis of market efficiency is incorrect. Econometric methods are proposed which allow for consistent (though not fully efficient) estimation of the parameters and their standard errors. This paper also presents a new approach for testing exchange market efficiency. This approach is based on a general time series process generating the spot and forward exchange rate. The hypothesis of efficiency implies a set of cross-equation restrictions imposed on the parameters of the time series model. This paper derives these restrictions, proposes a maximum likelihood method of estimating the constrained likelihood function, estimates the model and tests the validity of the restrictions with a likelihood ration statistic.

Speculation and the Forward Foreign Exchange Rate: A Note

Abstract: ONE OF THE MOST widely used models dealing with the effects of speculation on the forward foreign exchange rate is the so-called "Modern Theory of the Forward Foreign Exchange Rate" which stresses the role of both interest arbitrage and speculation in the determination of the forward rate (see Grubel [2]). Traditionally, the reduced form of the model expresses the forward foreign exchange rate as a weighted average of the covered interest-parity exchange rate on one hand and of the future spot rate expected to prevail at the maturity date of the forward contract on the other hand. Empirical work based on this reduced form is found in Stoll [6], Kesselman [4], Haas [3], and McCallum [5]. This specification, in which speculation on the forward foreign exchange market is implicitly analyzed in terms of the current forward exchange rate and the expected future spot exchange rate only, is unduly restrictive. The options facing the speculator are indeed much broader. The speculator does not need to get out of his speculative position by buying or selling the relevant currency on the spot market at the date of delivery. He can take his gain at any time between the date of the initial contract and the delivery date by entering into an offsetting transaction on the forward market for the same delivery date as soon as the corresponding forward rate is lower than the rate at which he sold forward initially. For example, a speculator expecting a depreciation of sterling and having sold forward sterling in January at $2.00 for delivery in July may take his gain by buying the sterling forward in April if at that time the three-month forward rate of sterling is, say, $1.85. The possibility to speculate by combining two offsetting forward transactions contracted at two different moments in time but for the same delivery date, without any operation on the spot market at that date, has an important implication: the expected future spot rate is not the only key variable determining speculators' decisions. Speculators can decide to speculate on a future forward rate, following exactly the same principles as when speculating on the future spot rate. They will thus sell forward foreign exchange if the current forward exchange rate is higher than the expected value of a future forward rate for contracts involving the same delivery date, and buy forward in the opposite case. If, for example, speculators anticipate that, in three months, the three-month forward exchange rate for sterling will be lower than the present forward exchange for sixmonth contracts, they expect to make a speculative gain by selling sterling today on the six-month forward foreign exchange market and buying sterling forward

The Forward Exchange Rate

Abstract: The analysis of international capital flows, and their impact on exchange rates and the domestic economy, becomes more complex though more realistic when forward as well as spot exchange transactions are incorporated. The role of the forward market is important in three ways: (i) movements in the forward exchange rate affect arbitrage calculations which determine international capital flows: (ii) forward exchange transactions and changes in the forward rate are important elements in interest-rate and monetary linkages between countries; and (iii) official (central bank) intervention in the forward exchange market is a potentially powerful means of influencing the volume and pattern of capital flows. More specifically, autonomous forward exchange transactions (such as speculative forward sales of a currency) may influence the relative rates of return between investments in different currencies, and hence cause wealth-holders to rearrange their portfolio of wealth between countries. Also, counterpart forward transactions to spot capital flows induce movements in forward rates which in turn alter the arbitrage calculation resulting from interest-rate changes. In this sense, movements in the forward rate have an equilibrating effect and tend to moderate the magnitude of capital flows in response to changes in interest-rate differentials. In this way the forward exchange market can be an important insulating mechanism which limits the extent of international financial interdependence through capital account transactions.

Expectations and the Forward Exchange Rate

Abstract: This paper provides an empirical examination of the hypothesis that the forward exchange rate provides an "optimal" forecast of the future spot ex-change rate, for five currencies relative to the dollar. This hypothesis provides a convenient norm for examining the erratic behavior of exchange rates; this erratic behavior represents an efficient market that is quickly incorporating new information into the current exchange rate. This hypothesis is analyzed using two distinct, but related, approaches. The first approach is based on a regression of spot rates on lagged forward rates. When using weekly data and a one month forward exchange rate, ordinary least squares regression analysis of market efficiency is incorrect. Econometric methods are proposed which allow for consistent (though not fully efficient) estimation of the parameters and their standard errors. This paper also presents a new approach for testing exchange market efficiency. This approach is based on a general time series process generating the spot and forward exchange rate. The hypothesis of efficiency implies a set of cross-equation restrictions imposed on the parameters of the time series model. This paper derives these restrictions, proposes a maximum likelihood method of estimating the constrained likelihood function, estimates the model and tests the validity of the restrictions with a likelihood ration statistic.

Forward Exchange Policy

Abstract: In earlier chapters the forward exchange rate, and its relation to the spot rate, was viewed as a key element in international arbitrage. A significant proportion of international capital transfers is conducted on a covered basis, and the forward market is an important medium for exchange-market speculation.

Forward Exchange Rate: A Banker’s View

Abstract: The standard theoretical approach to the analysis of the forward exchange rate and capital flows is challenged by foreign exchange dealers on the grounds that it ignores the mechanisms through which banks (which make the market) provide forward exchange facilities. The traditional analysis implicitly assumes either that speculators and arbitrageurs deal direct with each other or, more realistically, that banks act solely as brokers. The alternative analysis of the forward exchange market offered by bankers is frequently termed the Cambist approach.