Efficiency of the Foreign Exchange Market of Papua New Guinea During the Recent Float

Abstract

This paper examines the validity of the efficient market hypothesis (EMH) for the foreign exchange market of Papua New Guinea (PNG) using data on spot exchange rates for four major foreign currencies during the recent float. The unit root test results indicate that all the four exchange rates are random walks supporting the weak-form of the EMH. However, the Johansen multivariate cointegration test, the Granger causality test and variance decomposition analysis provide evidence that there are long-run as well as short-run predictable relationships among the spot exchange rates, refuting the validity of EMH in its semi-strong form. Further, evidence is found that the Australian dollar plays a vital role in driving the movements of exchange rates in PNG. These results have important implications for participants in the foreign exchange market and policy makers in PNG.Efficient market hypothesis, Papua New Guinea, foreign exchange market, Japanese yen, Variance decomposition