Testing the unbiased forward rate hypothesis in Vietnam Forex market
Abstract
Along with the integrating process, multinational corporations, which have
expanded their business broadly oversea, are showing their thirst of an effective tool to
forecast the future exchange rate. Understanding this emphasized need, many studies have
been worked on this area, especially, on the implications of using forward rate as an
indicator of future spot rate moments. Most of these studies are conducted based on
Forward Rate Unbiasedness Hypothesis, which states that the forward rate incorporates all
information about exchange rate expectation (Chiang, 1988). Data on actual spot currency
exchange rates and interest rates in each pair of countries are obtained to compute a series
of calculated forward rates under the assumption that Interest Rate Parity exists. To test
unbiased forward rate hypothesis (UFH), the ordinary least square (OLS) is employed with
the variation in spot rate (st+1 – st) as the dependent variable, and the calculated forward
premium (ft – st) as the independent variable. The procedure is repeated with interest rates
of different maturities from 15 currencies trading in Vietnam forex market, to assess the
appropriateness of the forecasting technique with respect to various maturities. Following
the usual finding of previous studies, results specify a strong forward rate bias for most of
15 currencies. The rejection of UFH is claimed for violating rational expectations and no
time-varying risk premium assumptions. Moreover, Financial Crisis should be considered
to have an effect on the results of this study.