Date of Award

Spring 1999

Document Type


Degree Name

Doctor of Business Administration (DBA)


Economics and Finance

First Advisor

Marc Chopin


The foreign exchange market is one of the most active financial markets. The sheer volume of trade in the foreign exchange market has captured the attention of many researchers. Since exchange rates began to float in 1973, there has been much empirical work on exchange rate behavior. The results from previous studies appear to be somewhat sensitive to econometric techniques employed. Thus, the correct statistical characterization of exchange rate behavior remains an open question.

Chapter 2 examines time-series behavior of monthly real exchange rates. The results show that real exchange rates do not follow a pure random walk process. Changes in monthly real exchange rates exhibit positive first-order autocorrelations at lower lags up to four-year horizons. Using the Beveridge-Nelson decomposition technique, all currencies allow the decomposition into permanent and transitory components. Further analysis implies that on average the transitory components account for more than half of the monthly variance of real exchange rates. Therefore, real exchange rates may be well represented by the sum of random walk and mean-reverting processes. The mean-reverting behavior is consistent with the assumptions underlying the purchasing power parity hypothesis and Dornbusch's overshooting exchange rate model.

Chapter 3 examines statistical properties of percentage changes in daily spot rates and their fundamental and non-fundamental components. The analysis shows that distributions of changes in spot rates vary over time due to changes in the variance of the fundamental component. The appraisal of the non-fundamental component implies temporary deviations from long-run equilibrium exchange rates. I propose to model spot rate changes as an AR(1) process with GARCH(1,1) errors. The model is able to explain non-stationary variances for all currencies studied.

Chapter 4 examines foreign exchange market efficiency using relative strength investment strategies. The study documents significant positive returns from a trading strategy that buys as value of a currency rises and sells as the currency value falls. The positive returns persist even after incorporating interest rate differentials but disappear when a constant currency risk premium is added to the model. The findings suggest that excess returns from the trading strategies are the result of compensation for risk, not that of market inefficiency.

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Finance Commons