Efficiency of Regulated and Unregulated FOREX Markets: An Analysis of Onshore and Offshore Renminbi Forward Markets

Abstract

Purpose

This study seeks to explore the presence and the relative strength of market efficiency in the onshore and offshore Renminbi (RMB) forward markets.

Methodology/approach

In the onshore and offshore foreign exchange markets, the RMB forward contracts are designed in similar ways. However, the underlying economic forces and regulatory frameworks are very different in these two markets. We first analyze the functioning of each market, by examining the covered interest rate parity (CIRP) conditions. Second, we explore the CIRP deviations in the two markets and quantify the role of market frictions and government interventions.

Findings

We find that the CIRP condition does not hold in either the onshore or the offshore RMB forward markets. We also find that the offshore market is more efficient than the onshore market in conveying private information about investors’ expectation.

Originality/value

Our results reveal that the onshore RMB forward market provides an imperfect platform for investors to manage their currency exposures. We suggest that by opening the offshore market to domestic participants and the onshore market to more foreigners, the forward rates may become more informative with a greater investor mix. These liberalization efforts are important steps in the right directions to improve market efficiency in the Chinese FOREX market.

Citation

Huszár, Z.R., Tan, R.S.K. and Zhang, W. (2016), "Efficiency of Regulated and Unregulated FOREX Markets: An Analysis of Onshore and Offshore Renminbi Forward Markets", The Political Economy of Chinese Finance (International Finance Review, Vol. 17), Emerald Group Publishing Limited, Leeds, pp. 371-392. https://doi.org/10.1108/S1569-376720160000017019