ABSTRACT
One of the most researched areas in international finance concerns the relationship between forward exchange rates and expected future spot rates. This chapter reviews the relationship between conintegrating regressions and error correction models. It describes the data and implements the Johansen procedure. The chapter shows how the Granger representation theorem breaks down in the presence of noninvertible moving average errors. Michael J. Moore builds on Craig S. Hakkio and Mark Rush with a detailed derivation of the restrictions which have to be placed on the ECM in equation to ensure that it is consistent with the joint hypotheses of market efficiency and risk neutrality. The chapter analyses the data that obtained from Richard T. Baillie and Tim Bollerslev who tested the joint hypotheses of efficiency and risk neutrality on seven currencies sampled daily between March 1, 1980, and January 28, 1985.
