Speculative Prices as Random Walks: An Analysis of Ten Time Series of Flexible Exchange Rates

There is a growing body of work on the behavior of prices in speculative markets,' much of which is concerned with the random walk hypothesis of price behavior. In Section II of this paper, following a brief sketch of the random walk hypothesis, tests of this hypothesis are conducted on a new set of data consisting of ten flexible exchange rate time series. In sum, significant departures from the random walk hypothesis are found in three different tests for serial dependence. These departures appear to be substantially larger than those that have been found in other markets. In Section III it is argued that the random walk hypothesis can be derived from the theory of rational speculative behavior only if transactions costs and inventory-carrying costs are zero. When these costs are considered, we no longer expect prices to follow a random walk. Evidence is then presented to support the contention that at least some of the dependence in the flexible exchange rate time series is a result of transactions costs. Finally, in Section IV there is a summary of the findings and a discussion of their implications for the random walk hypothesis and for the hypothesis of rational speculative behavior.