Testing the Unbiasedness Hypothesis of Foreign Exchange Rates and the Analysis of Transformations.

Recent researchers have utilized various functional forms for testing the hypothesis that the forward rate is an unbiased predictor of future spot rates in foreign exchange markets. We compare a large number of these functional forms for a similar time period and test their consistency with the data for five major currencies. Our results imply that certain functional form models may be inappropriate for some currencies. Researchers must, therefore, be cautious of misspecification due to erroneous functional forms when testing the unbiased forward rate hypothesis. Copyright 1996 by Kluwer Academic Publishers