Scott W. Barnhart

Testing the Unbiased Forward Rate Hypothesis: Evidence on Unit Roots, Co-Integration and Stochastic Coefficients

In this paper, we demonstrate that the conflicting results found in the literature of tests of the unbiased forward rate hypothesis (UFRH) depend upon the econometric specification used as well as differences in the time period of estimation. It is established that the time series properties of spot and forward exchange rate data rule out certain econometric specifications used to test the UFRH. Specifically, we find that both spot and forward exchange rates for the U.K., Germany, Japan, and Canada have unit roots and are cointegrated. We also find that the co-integrating parameter in the regression of realized spot on forward rates for each currency is approximately one, implying that researchers who use this specification to test the UFRH may falsely accept the hypothesis simply because of the specification used in the test. Using an alternative error correction specification, we find that the UFRH is resoundingly rejected for all currencies and that the coefficients in this specification exhibit temporal instability. More importantly, we find that the evolution of the estimated parameters is becoming increasingly inconsistent with the UFRH with the passage of time. We conclude the paper with an investigation into potential causes for the gross violation of the UFRH.

Non-Informative Tests of the Unbiased Forward Exchange Rate

This paper reexamines a familiar but unsettling result in the foreign exchange literature: that the forward rate is not an unbiased predictor of the future spot rate. The paper outlines why some frequently used tests of unbiasedness are non-informative in the sense that they are incapable of correctly testing the hypothesis. Specifically, many of these tests are based on regressions that suffer from simultaneity bias, resulting in biased and inconsistent estimators. This is true whether the tests are conducted using stationary or non-stationary data. We demonstrate this point both analytically and with simulations. Tests of co-integration, which are not subject to the critique presented in the paper, generally fail to reject unbiasedness.

Some answers to puzzles in testing unbiasedness in the foreign exchange market

Similar but alternative specifications of tests of forward rate unbiasedness provide conflicting evidence on the rejection of the hypothesis. These conflicting results are reconciled by demonstrating that although the root cause is simultaneity bias, the severity of this bias and the resulting rejection or non-rejection of the hypothesis depends entirely on the relative error variance empirical regularity common to foreign exchange markets. The analysis presented here applies to both stationary and non-stationary specifications of the model.

Measuring Market Timing: An InternationalExamination of Market Timing Conditions

The objective of this article is to introduce an expost measure of market timing independent of luck or skill in order to identify when market conditions are more favorable to successful market timing and to evaluate the conclusions of several previous academic studies. We propose that basic market conditions rotate from favoring buy-and-hold investing to favoring market timing strategies, and that these conditions can be measured in any equity market by tracking the results of a constant skilled market timer. We seek to identify what market return conditions are more conducive to successful timing for this constant-skilled investor and when these conditions have been present over our sample period. The MTBH metric was calculated for 44 countries for 14 years and compares findings of eight previous studies of the timing ability in mutual fund managers, stock traders, option traders, and individual investors across several U.S. and international indexes. The MTBH metric is particularly accurate in explaining the positive timing results for options traders and hedge fund managers, but not as accurate in explaining mutual fund timing. The MTBH metric provides an alternative explanation for non-persistent market-timing results outside of the investors’ behavior or skill and can be applied to any foreign or domestic market to evaluate managers’ timing results.

When to Time in the Stock Market: An International Examination of Factors that Influence Market Timing

The objective of this study is to determine if readily available finance and macro-economic variables can explain which years have favored market timing strategies versus which years favored buy and hold investing, in order to help traders determine when to allocate funds from passive to active investment strategies. We find that when real GDP growth rates, inflation rates, and PE ratios were low or negative, and when dividend yields were high, market timing strategies were favorable across 44 country market indexes from 1995–2008. These results are robust to country level of development, negative market return years, and other control variables. The conditions for pursuing market timing strategies were time-variant and detectable with macro-economic and finance variables. We introduce and test a new metric, Market Timing–Buy and Hold (MTBH), which measures the conditions of pursuing market timing strategies relative to buy and hold investing. The MTBH metric is an ex post measure that allows one to examine when it has been advantageous to switch from buy and hold investing to a market timing strategy using macro-economic and financial variables.