No 13: The forward rate as an optimal predictor of the future spot rate in South Africa : An econometric analysis
G R Wesso
Last Modified Date:
2020-10-01, 09:31 PM
Publications > Occasional Papers
This paper investigates empirically the relationship between spot and forward rates in the South African foreign exchange market for the period 1987 to 1998. There is often the belief that the forward rate must be an unbiased predictor of the future spot rate, otherwise speculators could profit from the bias by taking one position in the spot market and the opposite position in the forward market.Various hypotheses on rational expectations are therefore tested in this regard. Unit-root tests are performed to confirm the validity of the use of the Rand/US$ exchange rate specification in level form. For the entire sample period, the empirical evidence indicates that both current spot rates and current forward rates are significant in the predictions of the future spot rate. However, the current spot rates provide better forecasts of the future spot rates than do the current forward rates. Empirical tests also indicate that estimated coefficients for the forward rates (and the spot rates) fall below one, rejecting the "unbi-ased predictor" hypothesis. Rolling regression and structural stability tests are used to test for the sensitivity of estimated coefficients to new information. This study suggests that, in addition to a search for explanatory variables such as "news" and risk factors, further research should be done on an analysis of the time-variant coefficients.