Testing Filter-Rule Profits in the Foreign Exchange Market
The change in the exchange rate can be decomposed into four components: (1) the interest rate differential between the two currencies involved, (2) the risk premium, (3) the systematic error-of-forecast of the exchange rate, and (4) a random forecast error. The systematic components generate trends in a series. Trends due to systematic errors-of-expectations imply market inefficiency, whereas trends due to the other two systematic components of the change in the exchange rate do not.
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