Efficiency in the Forward Exchange Market: An Application of Cointegration

This paper defines a cointegrated system and discusses the implications of cointegration for efficiency in the forward exchange market using Irish daily data.Tests are discussed and carried out and the results are compared and contrasted with those of an earlier paper by Leddin (1988) who examined efficiency in the Irish forward market using different techniques.In contrast with the results which were obtained by Hakkio and Rush (1987), who used the cointegration approach to study efficiency in the US and German forward exchange markets, the study finds substantial evidence of market inefficiency.*The views expressed in this paper are the author's own and are not necessarily those held by the Bank.I wish to thank colleagues in the Bank, especially Michael Moore and John Frain, and also two anonymous referees, for helpful advice and suggestions.Any remaining errors are the author's own responsibility.1.However, if a has to be estimated from the cointegrating regression of Att'Xj on a constant and a'X _., then the D-F significance levels given in Dickey-Fuller (1981) are no longer valid.