REVISITING THE MARTINGALE HYPOTHESIS FOREXCHANGE RATES

We consider a simple random walk process, a special case ofthe Martingale model, which exhibits a deterministic break in its drift term,for instance, from positive to negative. This particular example can be aplausible model for a time series on exchange rates which displays a persistentcurrency appreciation period followed by a long depreciation era. Wedemonstrate both theoretically and by simulation that when the standardvariance-ratio test is applied to this process, the phenomenon of spuriousrejections of the Martingale hypothesis can occur. We discuss some implicationof this finding on the previously uncovered empirical evidence againstthe Martingale hypothesis for exchange rates...