Using ARIMA Forecasts to Explore the Efficiency of the Forward Reichsmark Market

We explore the efficiency of the forward reichsmark market in
Vienna between 1876 and 1914. We estimate ARIMA models of the spot
exchange rate in order to forecast the one-month-ahead spot rate.
In turn we compare these forecasts to the contemporaneous forward
rate, i.e., the market's forecast of the future spot rate. We find
that shortly after the introduction of a "shadow" gold standard in
the mid-1890s the forward rate became a considerably better
predictor of the future spot rate than during the prior flexible
exchange rate regime. Between 1907 and 1914 forecast errors were
between a half and one-fourth of their pre-1896 level. This implies
that the Austro-Hungarian Bank's policy of defending the gold value
of the currency was successful in improving the efficiency of the
foreign exchange market.