NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Heterogeneous Expectations and Tests of Efficiency in the Yen/Dollar Forward Foreign Exchange Rate Market

Graham Elliott, Takatoshi Ito

NBER Working Paper No. 5376
Issued in December 1995
NBER Program(s):International Finance and Macroeconomics

This paper examines the efficiency of the forward yen/dollar market using micro survey data. We first argue that the conventional tests of efficiency (unbiasedness) of the forward rate or of the survey forecasts do not correspond directly to the zero-profit condition. Instead, we use the survey data to calculate directly potential profits of individual forecasters based on a natural trading rule. We find that although the survey data are not the best predictor of future spot rate in terms of typical mean square forecast error criteria, the survey data can be used to obtain on average positive profits. However, these profits are small and highly variable. We also examine profits generated by a trading rule using regression forecasts, where forward premium is an explanatory variable. These profits are also small and highly variable.

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Document Object Identifier (DOI): 10.3386/w5376

Published: Journal of Monetary Economics, Vol. 43, no. 2 (April 1999): 435-456.

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