Abstract
A fundamental premise in financial economics concerns the assumption that equilibrium prices exist between spot and forward exchange rates and
interest rate markets. Interest parity arbitrage ensures that equilibrium prices in forward currency markets are maintained based upon interest rate
differentials. This study investigates the sensitivity of the residuals between estimated and actual prices in forward markets-which should be in
equilibrium- to sample period bias. Using a long term (25 year) daily time series of spot and forward USD/Yen prices and the equivalent maturity
short-term US and Japanese interest rates, we find evidence of considerable variation in the departures from equilibrium over the sample period. This
phenomena is consistent with persistence in the type of arbitrage available in the forward markets (arbitrageurs can take either a long (bought) or short
(sold) position). When investigated from a monthly perspective there is also statistically significant evidence of seasonality - for example, there are
more arbitrage possibilities available during the northern summer than in the northern winter, which is clearly associated with the liquidity of foreign
exchange markets Finally, sophisticated filtering techniques are applied to remove the presence of any short-term dependence in the residuals: the whole
sample and each of the sub-periods are filtered for AR(1), MA(1), ARMA (1,1) and GARCH (1,1) dependencies. We then apply a local version of the Hurst rescaled range statistic to estimate the presence of long-term dependence. These tests reveal episodes of both positive and negative dependence over the various sample periods, which appear to be linked to episodes of dollar decline/yen appreciation, or vice versa. We conclude that sample period selection remains a critical issue when investigating the presence of long-term dependence in currency returns.
interest rate markets. Interest parity arbitrage ensures that equilibrium prices in forward currency markets are maintained based upon interest rate
differentials. This study investigates the sensitivity of the residuals between estimated and actual prices in forward markets-which should be in
equilibrium- to sample period bias. Using a long term (25 year) daily time series of spot and forward USD/Yen prices and the equivalent maturity
short-term US and Japanese interest rates, we find evidence of considerable variation in the departures from equilibrium over the sample period. This
phenomena is consistent with persistence in the type of arbitrage available in the forward markets (arbitrageurs can take either a long (bought) or short
(sold) position). When investigated from a monthly perspective there is also statistically significant evidence of seasonality - for example, there are
more arbitrage possibilities available during the northern summer than in the northern winter, which is clearly associated with the liquidity of foreign
exchange markets Finally, sophisticated filtering techniques are applied to remove the presence of any short-term dependence in the residuals: the whole
sample and each of the sub-periods are filtered for AR(1), MA(1), ARMA (1,1) and GARCH (1,1) dependencies. We then apply a local version of the Hurst rescaled range statistic to estimate the presence of long-term dependence. These tests reveal episodes of both positive and negative dependence over the various sample periods, which appear to be linked to episodes of dollar decline/yen appreciation, or vice versa. We conclude that sample period selection remains a critical issue when investigating the presence of long-term dependence in currency returns.
| Original language | English |
|---|---|
| Pages | 1-1 |
| Number of pages | 1 |
| Publication status | Published - 2005 |
| Event | International Association for Statistical Computing 3rd World Conference on Computational Statistics & Data Analysis - Limassol, Cyprus Duration: 28 Oct 2005 → 31 Oct 2005 |
Conference
| Conference | International Association for Statistical Computing 3rd World Conference on Computational Statistics & Data Analysis |
|---|---|
| City | Limassol, Cyprus |
| Period | 28/10/05 → 31/10/05 |