Memory properties of the forward premium: A study on South African exchange rates

Abstract

The forward rate unbiasedness hypothesis states that the current forward rate should be an unbiased forecaster of the future spot rate. Inference has always been done under the assumption that the forward premium is a stationary short memory series. Recent empirical results have indicated that this assumption is not valid. Standard unit root tests performed on the forward premium often indicate infinite long memory. However, in recent literature fractionally integrated models have been applied for the forward premium. Empirical analysis is usually performed on exchange rates of developed economies. In this article, the South African Rand-Dollar exchange rate is considered and the focus is therefore on a developing country. A bootstrap method for determining standard errors and confidence limits is described and implemented.