This paper develops a model for the forward and spot exchange rate which allows for the presence of a Markov switching risk premium in the forward market and considers the issue of testing the unbiased forward exchange rate (LIFER) hypothesis. Using US/UK data, it is shown that the LIFER hypothesis cannot be rejected, provided that instrumental variables are used to account for within-regime correlation between explanatory variables and disturbances in the Markov switching model on which the test is based. Copyright © 2005 John Wiley & Sons, Ltd.
Testing the unbiased forward exchange rate hypothesis using a Markov switching model and instrumental variables
Fabio Spagnolo;
2005-01-01
Abstract
This paper develops a model for the forward and spot exchange rate which allows for the presence of a Markov switching risk premium in the forward market and considers the issue of testing the unbiased forward exchange rate (LIFER) hypothesis. Using US/UK data, it is shown that the LIFER hypothesis cannot be rejected, provided that instrumental variables are used to account for within-regime correlation between explanatory variables and disturbances in the Markov switching model on which the test is based. Copyright © 2005 John Wiley & Sons, Ltd.File in questo prodotto:
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