Testing for Non-Linearity in the Foreign Currency Futures Market
University of Wales, Bangor, Research Paper No. RP 97/27
Posted: 13 Mar 2007
Abstract
In this paper, the issue of nonlinearity in foreign currency futures markets is examined. Daily returns are found to be linear independent but nonlinear dependent. That is, they are correlated through their second moment. However, when the BDS test is applied, the results are inconclusive as the null hypothesis of i.i.d is not rejected in some cases but rejected in others. This rejection of i.i.d in the returns and filtered returns series arises solely from the variance of the process as suggested by the third moment test. As such, GARCH(1,1) models are fitted to all the return series and the corresponding standardized residuals are tested for i.i.d behavior. It is shown that the model brings about some improvement in that nonlinear dependence in the return series is reduced considerably.
Keywords: linear dependent, nonlinearity, currency futures, GARCH
JEL Classification: G13, G14
Suggested Citation: Suggested Citation