The spot-forward relationship revisited: an ERM perspective

Macdonald, R. and Moore, M.J. (2001) The spot-forward relationship revisited: an ERM perspective. Journal of International Financial Markets, Institutions and Money, 11(1), pp. 29-52. (doi: 10.1016/S1042-4431(00)00034-2)

Abstract

We re-examine the relationship between spot and forward exchange rates using Hansen's stability tests for co-integrating equations. Two numeraire currencies are used: the DM as the ERM's nth currency and the US$ as a ‘control’. The striking feature is that while the spot–forward relationship displays broad stability against the dollar, precisely the opposite is true against the DM. We investigate whether this result can be interpreted as evidence that the ERM target zones lacked credibility. Using the general-to-specific modelling framework, we develop dynamic relationships that can be readily used to interpret the source of the Hansen instability. Our results also have implications for the appropriate way to test the unbiasedness of the forward exchange rate.

• Item Type: Articles
• Status: Published
• Refereed: Yes
• Glasgow Author(s) Enlighten ID: MacDonald, Professor Ronald
• Authors: Macdonald, R., and Moore, M.J.
• College/School: College of Social Sciences > Adam Smith Business School > Economics
• Journal Name: Journal of International Financial Markets, Institutions and Money
• ISSN: 1042-4431
• Published Online: 21 December 2000