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This paper looks at issues surrounding the testing of fractional inte- gration and nonlinearity in relation to the forward exchange rate anomaly of Fama (1984). Recent tests for fractional integration and nonlinear- ity are discussed and used to investigate the behaviour of three exchange rates and premiums. The findings provide some support for I(1) exchange rates but suggest fractionality for premiums, mixed evidence on cointe- gration, and a strong possibility of time-wise nonlinearity. Significantly, when the nonlinearity is modelled using a random field regression, the forward anomaly disappears.

Some Empirical Observations on the Forward Exchange Rate Anomaly