Exogeneity and forward rate unbiasedness

Recent studies have rejected the forward rate efficiency hypothesis because of a failure to find support for the forward rate unbiasedness condition (FRUC). This condition states that spot and forward rates should be cointegrated with a unit cointegrating vector. These studies have focused on inferences drawn from partial system error-correction approaches that make critical assumptions concerning the exogeneity of forward rates. Taking a full systems approach to estimation without any a priori weak exogeneity assumptions, we find support for FRUC, and that spot rates, not forward rates, are weakly exogenous in the sense of Engle, Hendry, and Richard (1983). The latter finding implies that the rejection of the FRUC in prior research may be due to the incorrect implied exogeneity assumptions. (JEL F31, F40, C32).