Analysis of the Yield on Foreign Exchange Bearer Certificates : Rationality and Financial Behavior in Pakistan

Financial market efficiency in Pakistan is investigated through an analysis of the secondary market for Foreign Exchange Bearer Certificates (FEBC). A reduced form model for FEBC yield is specified and estimated. The FEBC`s roles as an avenue for relaxing the legal foreign exchange constraint, and for transferring funds from the informal to the formal sectors, are shown to be significant predictors of yield behavior. Adjusting for these effects, yield sensitivity to local and international rates of return is sustained. Financial reform appears to have increased the impact on FEBC yield of interest rate movements, and reduced those of regulation effects. The model outperforms conventional interest parity specifications as a description of FEBC yield. Empirical results suggest a `rational` interest rate structure is underlying regulation laden rates of return