L13_ME - This class FOREX Market Efficiency(chapter 7...

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1 Lecture 13 FOREX Market Efficiency 1 This class FOREX Market Efficiency (chapter 7) Theory of Market Efficiency Empirical Evidence on Exchange Market Efficiency Policy Matters Lecture 13 FOREX Market Efficiency 2 Theory of Market Efficiency Eugene Fama (1970) The FOREX market is said to be efficient if market prices fully reflect available information .
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2 Lecture 13 FOREX Market Efficiency 3 Market Efficiency Let r t+1 = rate of return on an asset between periods t and t+1. E(r t+1 | I t ) = return conditional on the information available in period t. Then the excess market return is: Z t+1 = r t+1 -E(r t+1 | I t ) Lecture 13 FOREX Market Efficiency 4 A market is said to be efficient if: E(Z t+1 | I t ) = 0. no expected excess returns. corr(Z t+k , Z t ) = 0 for all k. => no correlation between an excess return in period t and one in some other period
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3 Lecture 13 FOREX Market Efficiency 5 Pictures of Efficient Markets r 0 Time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . r t+1 When the equilibrium expected return is constant . .. E(r t+1 | I t ) Lecture 13 FOREX Market Efficiency 6 Suppose returns looked like… Are there excess returns? time . . . . . . . . . . . . . . . . . . . . .
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4 Lecture 13 FOREX Market Efficiency 7 Depends… if your “model” says that r = r 0 r 0 time . . . . . . . . . . . . . . . . . . . . . Lecture 13 FOREX Market Efficiency 8 But if your model says that. .. r 0 time . . . . . . . . . . . . . . . . . . . . .
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5 Lecture 13 FOREX Market Efficiency 9 Test of a joint hypothesis : 1. people use information efficiently (no excess returns) 2. specification of market equilibrium Test of Market Efficiency Lecture 13 FOREX Market Efficiency 10 If market efficiency is rejected, because 1. market prices don’t fully reflect information OR 2. equilibrium benchmark is incorrect Test of Market Efficiency
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6 Lecture 13 FOREX Market Efficiency 11 What is the “available” information set? Weak form - historical information => Tests of return predictability Semistrong form - publicly available information => Event studies Strong form - all available information, including proprietary and insider information => Tests for private information => impact of FX interventions
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L13_ME - This class FOREX Market Efficiency(chapter 7...

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