Posted: May 23rd, 2022

Review of Foreign Exchange Rates and Foreign Market

 

 

Review of Foreign Exchange Rates and Foreign Market

A Test of its Efficiency in Indonesia

 

 

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Review of Foreign Exchange Rates and Foreign Market

A Test of its Efficiency in Indonesia

Introduction

This study looks at the economic theories and their relationship to the foreign exchange market. To aid this study, we look at the peer-reviewed paper A Test of The Efficiency of The Foreign Exchange Market in Indonesia,” published in 2019. The article is based on the fact that the empirical evidence on the efficiency of the foreign exchange market is inconclusive (Iyke, 2019). The article, therefore, tests whether the foreign exchange market of Indonesia is efficient. The article examines the Efficient Market Hypothesis (EMH) by employing a new generalized autoregressive conditional heteroskedasticity-based unit root.” The article uses this model in examining foreign exchange market efficiency because it accommodates two endogenous heteroskedasticity and structural breaks.

Studying this article is because the article has a strong relationship with economic theories regarding exchange rates which play a key role in the foreign market. Rates of exchange rates extraordinarily impact a country’s financial development and decide the level of the monetary strength of any state (Hofmaan, Shin & Shin, 2021; Fama & French, 2012). They assume an essential part in the degree of exchange of a country that is fundamental in the most open economy worldwide. To this end, trade rates are among the most dissected, watched, and controlled financial measures by state-run administrations. A few monetary speculations in this study incorporate PPP, a near financial hypothesis that thinks about monetary forms between nations utilizing a bushel of merchandise approach (Iyke, 2019). It is a measurement used prominently by monetary experts in looking at financial efficiency, monetary standards, and expectation for everyday comforts of individuals between nations.

Therefore, the article under review provides common financial variable characteristics, an exchange rate that structural breaks. These breaks often result from policy changes, economic fundamentals, and sudden downturns in the economy (Narayan, Liu & Westerlund (2016). The articles utilize some of the structural break problems in the past literature to address the various structural break units. The main contribution aimed of the article is to avoid the assumption error using the developed test for unit roots of the testing market.

Summary of Key Concepts

A few points can be realized from the article, which ranges from the article’s contribution to the limitations of the article. To begin with, the model (Efficient market hypothesis) utilized in the article contends that asset prices incorporate all available data. Various studies support the article regarding the model validity plus mixed results leading to various hypothesis flexible forms (Fama & French, 2012). The Efficient Market Hypothesis model adopted in the study has been mainly tested and utilized for the stock markets. It recently achieved important FX markets’ attention. The paper also examined the implication of the acceptance or rejection of the unit root on the rates of exchange’s speed of changing to equilibrium. The article first shows that the exchange rates demonstrate up to two structural breaks in Indonesia. The two tests performed in the article show that structural breaks are accounted for by the unit roots but not the heteroscedasticity (Iyke, 2019). We further investigate the speculation by representing both underlying breaks and heteroskedasticity.

In the article, the author observed that the dismissal pace of the EMH is significantly higher (half). Fundamentally outcomes are tracked down to be the most robust utilizing everyday data. In addition, FX markets were less effective pre-emergency when we split the example into when the Asian Monetary Crisis (AFC). The article analyzes the change of these trade rates to balance. It is observed that around seventy percent of the trade rates return to their mean in one month following a deviation. This could imply that the FX market is productive for the time being.

Therefore, several key aspects emerge from the article besides those mentioned above. It can be concluded from the article that the significance of this exact adventure lies in the way that a dismissal of the FX market effectiveness implies financial backers or potentially merchants can separate benefits by taking advantage of evaluating irregularities. Furthermore, the approaches sought after under the presumption of an effective market could be incapable (Bostan, Toderascu & Firtescu, 2018). According to an arrangement viewpoint, this would require intercessions by the pertinent specialists to address the market mispricing. The experimental writing stays uncertain. Along these lines, unit root-used tests by and large treat primary basic mistakes of the test relapse as i.i.d. The solution presented by the article for these limits is to try FX market effectiveness utilizing a GARCH model. According to Iyke (2019), this approach manages endogenous heteroskedasticity and structural breaks.

Article Critique

The article “A Test of The Efficiency of The Foreign Exchange Market in Indonesia” discusses the efficiency of the Indonesian foreign exchange market. The writer discusses one of the most critical models that argue the full importation of prices and all available information. This is particularly significant because the researcher tries to demonstrate the utilization of economic models to support economic theories. One significant contribution made by the researcher in using the EMH model is the originality of the findings not based on literature alone. The writer discusses the incorporation of past literature in addressing what seems to be the main problem in the study. The use of past literature shows acknowledgment of other researchers’ work. In essence, the use of past literature becomes important to the researcher where, imminently, structural breaks are a persistent problem that many researchers have dealt with. The Asian Financial Crisis affected most countries, making the article relevant since it seeks to address the problem for the benefit of Indonesia and other Asian countries. Some critics of the utilized literature are explained further as follows.

The writer is seen to appraise Jiang, Krishnamurthy, and Lustig (2021), which is argued to blend the inefficiencies induced by humans with EMH. The theory is further discussed that markets adaptive markets are ecological systems where profits are competed for by heterogeneous agents. This theory is inconsistent with Ilzetzki, Reinhart, and Rogoff (2017), who argue that there is a dominant trading strategy in markets because all agents will exploit it, leading to zero profits.” The researcher utilizes monthly data on bilateral exchange rates between the country under study with its top trading partners. Such data is trusted and can relay information necessary for development. Adopting a sample period that reflects the actual time of intense trading between Indonesia and other partners shows confidence in the validity of the results since such data is up to date.

Another thing that strengthens the article is the use of a large sample size. Statistically, the more the sample size, the fewer chances of error incurring. In other words, we obtain a slight standard deviation which is a deviation from the sample mean. This improves the accuracy of the results, and therefore, the research can be adopted for further consideration. The researcher in the article is seen to agree that the suspicions fundamental the solid types of EMH are a long way from the real world and that markets can display powerless structure productivity (Singhal, Choudhary & Biswal, 2019). By and large, the feeble structure. EMH suggests that costs are eccentric and abundance returns are absent. Common trials of the frail structure EMH are the change proportion and unit root tests. We momentarily survey the difference proportion, and unit root concentrates in the accompanying and afterward feature our inspirations.

However, some other authors differ with the above argument where they contend that the data in their weak form do not support the variance ratio test. The change proportion trial of Lo (2014) has propelled the advancement of different adaptations of the test, including the difference proportion test, the various change proportion test (Fama & French, 2012), the programmed difference proportion, the difference proportion tests (Hofmaan, Shim & Shin, 2021), the wild bootstrap change proportion programmed difference proportion test (Bostan, Toderascu & Firtescu, 2018). Proof from concentrates on the change proportion tests is blended in light of the change proportion tests (Ilzetzki, Reinhart & Rogoff, 2012).

Moreover, the fact that the researcher adopted monthly data reduces the reliability of the results. Since the exchange rates between nations are tracked daily, monthly data may incur abnormalities. The researcher did not demonstrate more accurate and acceptable ways of dealing with missing data. The writer suggests filling the missing gaps with any data from the respective country’s banks that may not be accurate. Iyke (2019) argues that “This is not necessarily a disadvantage of the daily data. The main issue is that daily observations are not available for five of the exchange rates from 20 May 2013 to 06 January 2015.” This proves the writer to have been inconsistent and shows no motivation in the analysis. The researcher is expected to stretch and provide accurate and reliable information.

Conclusion

The vital aspect of the article that attracts this writing is that they strongly relate to economic theory. The study reviews the foreign exchange market marked by foreign exchange rates. These are important economic theories. The researcher was able to relate the importance of the study to economic theory. Some of the concepts that came out clearly in my conclusions include; the Indosian exchange rates exhibiting two structural breaks. The main implication drawn from the article is that FX market is inefficient in Indonesian. This way, the FX investors can get profits from such exchange rates. It is worth noting that investors might obtain or derive profits through the employment of a buy and hold strategy since FX markets seem to be efficient in the short term.

The article is of several benefits to the learners. By outlining how GARCH model-based test has been used to test the efficiency of the Indonesian FX market, then learners develop a new insight on the GARCH framework for the understanding of FX market activities. With this framework, leraners will understand the functions and structure of foreign exchange market. In line with the course outcomes, with this article, the learners will be in a position to calculate the asset returns in different currencies using exchange rates. Undoubtedly, the article also challenges the entire economic profession to see on how to mould and improve the capability of learners cope with different FX risks in their quest to invest in dynamic economies. In addition, the article is of relevance to learners, since they are enlightened to know on how to exploit pricing anomalies in the incidences when the market turns out to be ineffective. To ensure this, the learners have been guided on how to incorporate heteroscedasticity, structural breaks to test for underlying errors in FX markets. Indeed, with this approach, learners have been equipped with valuable knowledge of determining the effectiveness of FX market. This will help learners to have to capability to make good financial investment decisions, that is likely to impact the economic profession and the economy at large.

 

 

 

 

 

 

 

 

 

 

References

Bostan, I., Toderacu, C., & Firtescu, B. N. (2018). Exchange rate effects on international commercial trade competitiveness.Journal of Risk and Financial Management,11(2), 19.

Fama, E. F., & French, K. R. (2012). Size, Value, and Momentum in International Stock Returns. Journal of Financial Economics, 105, 457-472.

Hofmann, B., Shim, I., & Shin, H. S. (2021). Emerging market economy exchange rates and local currency bond markets amid the Covid-19 pandemic.Available at SSRN 3761875.

Ilzetzki, E., Reinhart, C. M., & Rogoff, K. S. (2017). Exchange Arrangements Entering The 21st Century: Which Anchor Will Hold? National Bureau of Economic Research (No. w23134).

Jiang, Z., Krishnamurthy, A., & Lustig, H. (2021). Foreign safe asset demand and the dollar exchange rate.The Journal of Finance,76(3), 1049-1089.

Lo, A.W. (2014). The Adaptive Markets Hypothesis: Market Efficiency from an Evolutionary Perspective. The Journal of Portfolio Management, 30, 1529

Narayan, P. K., Liu, R., & Westerlund, J. (2016). A GARCH Model for Testing Market Efficiency. Journal of International Financial Markets, Institutions and Money, 41, 121-138. Narayan, P. K., & Popp, S. (2010). A New Unit Root Test with Two Structural Breaks in Level and Slope at Unknown Time. Journal of Applied Statistics, 37, 1425-1438.

Singhal, S., Choudhary, S., & Biswal, P. C. (2019). Return and volatility linkages among International crude oil price, gold price, exchange rate and stock markets: Evidence from Mexico.Resources Policy,60, 255-261.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Appendix

Iyke, B. N. (2019). A test of the efficiency of the foreign exchange market in Indonesia.Buletin Ekonomi Moneter Dan Perbankan,21, 439-464.

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