COVERED INTEREST PARITY AND THE EFFICIENCY OF THE AUSTRALIAN DOLLAR FORWARD MARKET: A COINTEGRATION ANALYSIS USING DAILY DATA

Abstract

This paper examines covered interest parity and speculative efficiency using cointegration techniques on a daily data set for Australian dollar/US dollar spot and forward rates and Australian and US interest rates. Cointegreation between the forward premium and the interest rate differential in both the 3 month and 6 month markets establishes covered interest parity as a possible long run equilibrium relationship for the sample period. However, both a well defined EC mechanism and the fact that past changes in the interest rate differential help predict the forward premium suggest the markets did not utilise all available information efficiently. Neither the 3 month not he 6 month forward rate cointegrate with the spot rate implying that these variables may have drifted apart over the sample period. Speculative efficiency may be rejected for these markets.