Economics Department
Working Papers in Economics
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TITLE:
Forward Premiums and Market Efficiency: Panel Unit-root Evidence from the Term Structure of Forward Premiums
AUTHOR(S):
John T. Barkoulas, University of Tennessee
Christopher F. Baum, Boston College
Atreya Chakraborty, Charles River Associates
DOCUMENT TYPE: Article
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ABSTRACT:
A plausible explanation for cointegration among spot currency rates determined in efficient markets is the existence of a stationary, time-varying currency risk premium. Such an interpretation is contingent upon stationarity of the forward premium. However, empirical evidence on the stochastic properties of the forward premium series has been inconclusive. We apply a panel unit-root testÜthe Johansen likelihood ratio (JLR) testÜto forward exchange premiums by utilizing cross-sectional information from their term structure. In contrast to earlier studies, the JLR test provides decisive and temporally stable evidence in support of stationary forward premiums, and therefore foreign exchange market efficiency, for six major currencies.