A TEST OF THE EFFICIENCY OF THE FOREIGN EXCHANGE MARKET IN INDONESIA

Abstract

We test whether the Indonesian foreign exchange market is efficient. Since empirical evidence has been inconclusive, we employ a new generalized autoregressive conditional heteroskedasticity–based unit root test to examine the Efficient Market Hypothesis (EMH). The advantages of this model are that it accommodates two endogenous structural breaks and heteroskedasticity. Tests that account for structural breaks reject the EMH in only 29% of cases. When we accommodate both structural breaks and heteroskedasticity, we find the EMH is rejected in 50% of cases. Finally, we examine the half-life of exchange rates and find that 71% of rates revert to equilibrium within a month.