Is Mexico's Forward Exchange Rate Market Efficient?

Abstract

This study proves the hypothesis of no bias in the forward exchange rate for the Mexican exchange market. A nonlinear Markov model with regime change was used instead of a linear regression model. The model identifies two states in the behavior of the forward exchange rate: one in which the null hypothesis of efficiency holds and the other one in which it does not. With the linear model the hypothesis is rejected for both forward rates, 30 and 90 days. However, when using the two-state model it is not possible to reject the null hypothesis for the 30-day forward rate in the state identified as efficient, but can be rejected in the other state. For the 90-day forward rate, the two states cannot be distinguished. Therefore, the nonlinear two-state Markov model is superior to the traditional linear regression model to test the hypothesis of no bias in the forward exchange rate, which is rejected in periods of high economic and political uncertainty. JEL Classification: C22; C50; C51; E58; F31; G14 Keywords: Forward exchange rate; Unbiased Forward Exchange Rate Hypothesis; Mexican Foreign Exchange Market; Markov Switching; Market Efficiency ¿El mercado mexicano de tipo de cambio a futuro es eficiente?Resumen El estudio prueba la hipótesis de no sesgo de la tasa forward de tipo de cambio para el mercado cambiario mexicano. Se utilizó un modelo no lineal de Markov con cambio de régimen en vez de un modelo de regresión lineal. El modelo identifica dos estados en el comportamiento del tipo de cambio forward : uno en el que la hipótesis nula de eficiencia se sostiene y otro en el que no. Con el modelo lineal la hipótesis se rechaza para ambas tasas forward, 30 y 90 días. Sin embargo, con el modelo de dos estados no es posible rechazar la hipótesis nula para la tasa forward de 30 días en el estado identificado como eficiente, pero se rechaza en el otro estado, En el caso de la tasa de 90 días no se distingue entre los dos estados. Por lo tanto, el modelo no lineal de Markov de dos estados es superior al modelo de regresión lineal para probar la hipotesis de no sesgo del tipo de cambio, la cual es rechazada en periodos de alta incertidumbre económica y política. IntroductionThe unbiased forward exchange rate hypothesis (UFRH) states that the forward discount is an unbiased predictor of the future spot exchange rate if we assume risk neutrality and a covariance stationary risk premium. Acceptance of the UFRH should also imply that the foreign exchange market is efficient. If the foreign exchange market is efficient, the spot (forward) exchange rate should incorporate all available information, and it should not be possible to forecast one spot (forward) exchange rate as a function of another. Depending on the time period, selection of exchange rates and type of methodology, researchers have reached different conclusions about the efficient market hypothesis. Rapp and Sharma, (1999), for instance, find mixed evidence of market efficiency among spot and forward rate for each of the G-7 countries. They argue that mark...

Efficiency of Tanzania's foreign exchange market

“…Smoothed probabilities, which are calculated recursively based on the estimation sample, generally provide the most informative inference about the state in which the data generating process lies at a particular time. Overall, similar to Balcilar et al (2017), Islas‐Camargo et al (2018), Rabta et al (2016), and Spagnolo et al (2005), the Markov chain that drives changes in regime is highly persistent, so if the system is in either of the two regimes, it is likely to remain in that regime. However, given daily data estimations, Figures 6 and 7 show that both regimes shift back and forth very often.…”

Modeling and Projection of the Mexican Exchange Rate (Peso/Dollar): a Bayesian Approach for Model Selection

“…The model specification in monthly data based on the Bayes factor criteria, coincides with Islas-Camargo et al (2017) supporting a MS specification over the linear autoregressive model, who studied the efficiency in the forward exchange rate. However, in high frequency exchange rate (Peso/Dollar) data, the MS specification suggests three states instead of two.…”

“…The present paper is very close to Ibarra Salazar et al (2017) and Islas-Camargo et al (2017). In the first, determinants of the nominal exchange rate by structural models 205 suggested by the financial theory were studied.…”