International macroe.. - Free

Chapter 6Foreign Exchange MarketEfficiencyIn his second review article on efficient capital markets, Fama [49]writes,“I take the market efficiency hypothesis to be the simplestatement that security prices fully reßect all availableinformation.”He goes on to say,“. . . , market efficiency per se is not testable. It mustbe tested jointly with some model of equilibrium, an assetpricingmodel.”Market efficiency does not mean that asset returns are serially uncorrelated,nordoesitmeanthattheÞnancialmarkets present zeroexpected proÞts. The crux of market efficiency is that there are nounexploited excess proÞt opportunities. What is considered to be excessivedepends on the model of market equilibrium.This chapter is an introduction to the economics of foreign exchangemarket efficiency. We begin with an evaluation of the simplest model ofinternational currency and money-market equilibrium–uncovered interestparity. Econometric analyses show that it is strongly rejected by161