The Role of Speculation in the Forward Exchange Market: Some Consistent Estimates Assuming Rational Expectations.

Abstract

This paper develops and estimates an equilibrium condition relating to the modern t heory of forward exchange. The author uses high-quality, overlapping, weekly data for dollar-franc and dollar-sterling exchange and intere st rates, and utilizes a generalized method of moments estimator to y ield consistent and efficient estimates under the assumption of ratio nal expectations. The results suggest the dominance of speculation as a determinant of the dollar-sterling thirty-day forward rate, and gi ve more weight to arbitrage in the determination of the dollar-franc thirty-day forward rate. Copyright 1987 by Blackwell Publishing Ltd