Essays on the foreign exchange market and structural breaks

The major contribution of this dissertation is relating structural breaks in international financial market to the rejection of the foreign market efficiency hypothesis. More specifically, tests of structural breaks and/or parameter instability are used in this thesis to empirically test whether structural breaks have contributed to the discrepancies between forward exchange rates and future spot rates.;The design of the dissertation will involve three chapters: the first two chapters relate the test of MEH to the learning process due to multiple discrete breaks. The learning model is developed to explain the effects of structural breaks on the time series properties of the forward exchange rate forecast error. Based on empirical evidence, researchers generally reject the null hypothesis of MEH due to serial correlation in the exchange rate forecast error series. However, by employing a learning model, I find that the learning effect that occurs during a structural break can explain the existence of serial correlation and volatility clustering in the series.;In Chapter three, I consider a case where the parameter is not only subjected to discrete breaks but also follows some stochastic process. Special emphasis will be placed on the alternative model of testing the FRUH derived from the Kalman filtering. I prove that there is significant evidence of the influence of structural breaks on the exchange rate expectation. Although the data rejects the null hypothesis of the forward unbiasedness for the whole sample period, the evidence against the null hypothesis is greater following a structural break. After a structural break, rational investors may face difficulty in forecasting the exchange rate due to the uncertainty associated with the break as well as requiring a greater risk premium than during the tranquility period to compensate for the uncertainty.;Other researchers have suggested the rejection of MEH may be due to the irrationality of market participants or the existence of a risk premium, or to some combination of the two. In this study, I add to this by showing that the rejection of MEH may be due to a learning effect occurring during structural breaks.