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Testing for Purchasing Power Parity and Efficiency in the Taiwan Foreign Exchange Market - Financial and Economic Forecasting (Chapter 13)

In this chapter, the hypotheses of purchasing power parity (PPP) and market efficiency are tested for the bilateral exchange rate between the New Taiwan (N.T.) and the US dollar. Different test results lead to the conclusion that, a PPP relationship over the long term cannot be rejected confidently. Furthermore, an error correction analysis indicates that this long-term relationship may be helpful in explaining short-term movements in the exchange rate. For testing the efficiency of Taiwan's foreign exchange market, the relationship between the spot rate and forward rates is examined for 10-, 30- and 90-day contracts was examined using daily observations. The forward premium is spilt into two components, one due to risk and the other due to a forecasting error. Over the two consecutive sample periods examined (1 May 1992 to 15 February 1993, and 16 February to 31 December 1993) the results are suggestive of a time-varying risk premium in the former period. However, efficiency was found to be acceptable for the 30- and 90-day contracts during the latter sample period.