Foreign Exchange Rates as Unbiased Estimate of Future Sports Rates - Dissertation Example

Download file to see previous pages The study employed three methods of determining the existence of EMH with the intention of arriving at results that corroborate each other since any one method taken alone can never be assuredly accurate. The first method employs the regression of future spot rates against forwarding exchange premiums. The second method tests for a confirmation of the unbiased forward rate hypothesis which is indicated by the co-integration of the forward exchange rate and the future spot rate. The third method employs an analysis of EMH in real terms and also through regression modeling and equation estimation.

Each of the three methods provided evidence that the efficient market hypothesis is valid in the currencies exchange market, specifically in the Swiss franc – US dollar spot and forward exchange rates. The weak form of market efficiency has been tested and validated, for which reason investors and businesses would most likely not realize abnormal profits through the use of methods of technical analysis for price forecasting.
Introduction

Background of the problem
In the early sixties and prior, the exchange rates in international currencies were governed by the fixed exchange rate regime. From 1973, however, the general free-floating exchange rate regime was adopted by the major European central banks, with other international monetary systems adopting the same policy. As a result, companies with international exposure (there were very few “multinationals” then) were particularly prone to shifts in exchange rates of the currencies in which they dealt (Soenen, 1979). Companies with international operations would at any one time be purchasing raw materials in countries where they are cheap, with their local currency, and selling the finished products in other countries where the demand is great, also with their local currency, and from these expenditures and receipts, to convert to the currency of the home country to settle with financiers and payout interests and dividends in the home currency. The fluctuating exchange rates introduced risks that the firm’s financial management must address, which necessitated the search for a reliable forecasting tool by any means possible, econometrics included.

The implications in costs and possible savings in the form of abnormal returns are therefore substantial for businesses with regular foreign currency requirements. The intention of the trade is not to speculate, but to avoid additional erosion of business profits if it is possible. Market participants desire for the market to be transparent, for all information to be known and discounted, and for true value to be ascertainable.

This is the situation in the case of an efficient market. It is therefore a paradox that while investors desire for the market to be perfectly efficient, they are constantly in search of a method by which future prices could be predicted. This is because when a market is efficient, prices – in this case, exchange rates – are always at their full value, and therefore there is no method or technique that would predict any rise or fall in prices. The anticipation that prices will rise or fall according to a pattern means that not all information is fully disclosed, discounted, or factored in; it, therefore, assumes an inefficient market.

The motivation for the issue to be addressed in this study is, therefore, to find out if an efficient market does exist. ...Download file to see next pages Read More