EFFICIENCY OF FOREIGN EXCHANGE MARKETS : AN ANALYSIS OF THE ASIA PACIFIC CURRENCIES

Abstract

The aim of this study is to examine the efficiency of foreign exchange markets with respect to various Asia Pacific currencies. In particular, we are investigating the efficiency of the Japanese yen, Malaysian ringgit, Philippines peso, Singapore dollar, South Korean won and New Taiwan dollar in the spot market. Although many researchers have examined the efficiency of foreign exchange markets, few studies have looked at the Asia Pacific region. Furthermore, daily data is used and one of the tests covers a relatively long time span of sixteen and a half years. The Engle and Granger two-step procedure is employed to test for cointegration of the system of spot rates. Since cointegration would imply at least one causal flow in the system, any finding of cointegration is clearly inconsistent with the efficient market hypothesis. In addition, we also employ a vector autoregressive model to forecast the foreign exchange rates. The results are then compared with that of a simple martingale process. If the market is indeed efficient, it should not be possible for the vector autoregressive model to outperform the random walk model. The cointegration-based tests of market efficiency indicate that there is no evidence of cointegration between the spot rates. However, the results of the forecasting exercise are less conclusive as neither the vector autoregressive model nor the martingale model performed significantly better than the other. Thus, there appears to be some support for the efficiency of the foreign exchange market with respect to the Asia Pacific currencies. However, this conclusion should be accepted with caution in view of the limitations of the Engle and Granger two-step approach and tests of cointegration in general.