Currency Future Efficiency : Do Currency Futures Predict Future Spot Exchange Rates?

Abstract: This paper has tested the efficiency, weak form according to EMH, of the currency future market. The efficiency test has been incorporated in the research question since the market has to be efficient in order for the future to work as predictor of the future spot rate - Can currency futures be used as a tool for predicting futures spot exchange rate? The two sub questions are - Is the prediction power of currency futures stable over time and is the prediction power of currency futures similar for different currencies?   The main theory in the research is the Efficient Market Hypothesis and the Random Walk Hypothesis. The research was conducted with a positivistic philosophy in conjunction with a realistic approach. Since the research question has been deducted from the theoretical framework the research has a deductive approach, a quantitative technique was adapted when the data at hand was mainly future and spot rate data.   Data on 13 currencies ranging from 2005 to 2010 was used. The prices were available in weekly intervals for all currencies except for the Brazilian real, Swiss frank and the Mexican peso. The statistical test that was used is the Augmented Dickey-Fuller test and the Phillips-Ouliaris cointegration test. The test was conducted on the whole timeframe. After that, the data was divided into three sub periods to show if the efficiency where different in the period before the crises (2005-2007), during the crises (2008-2009) and after the crises (2010). The test has also been done on annual and quarterly data to show if the length of the time period tested has an effect on efficiency. The PO test has been conducted on all data and the ADF test has been conducted on the whole timeframe and the sub periods.   The results show that, ten of the currencies which we had weakly data, the future is a good predictor of the future spot exchange rate. This is true when the tests are done on an interval of one year and more. For the three currencies that we had monthly data, the results showed cointegration on the whole timeframe. When shorter time periods were tested the currencies that consisted of monthly data showed no cointegration sooner than the weakly data. When test is done on quarterly data, only one test is cointegrated. It cannot concluded that, the future was not a good predictor for the future spot exchange rate during this time, merely that this particular test might be the true one and that the tests where not able to capture it. Several reasons for this are presented in the analysis chapter, where the statistical tests and their design are mentioned among other reasons.