Further evidence of forward exchange market efficiency: an application of cointegration using German and UK data

Abstract

The purpose of this paper is to explore the hypothesis that the Irish forward exchange market is efficient. The simple market efficiency hypothesis assumes investors are risk neutral and that agents are rational, i.e., they use all available information. Testing for efficient markets is thus a test of a joint hypothesis. In the case of forward market efficiency, the forward rate is required to be an unbiased predictor of the future spot rate. However, rejection of the joint hypothesis does not necessarily imply market inefficiency. If investors are risk-averse, then they will require a risk premium to compensate for bearing exchange rate risk. But this does not give rise to profitable arbitrage opportunities. Only if there is inefficient use of available information, will there be unexploited profits ? and by definition, market inefficiencies present.