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

Abstract

This study provides new insights about the functioning of Renminbi (RMB) FOREX market by testing the market efficiency in the onshore and offshore RMB FOREX markets. In the onshore and offshore FOREX 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 examine the functioning of each market by testing the covered interest rate parity (CIRP) conditions and explore the CIRP deviations in relation to market frictions and government interventions. While the CIRP conditions do not hold in either markets, the offshore market is shown to be more efficient by conveying more private information about investors’ expectation. Overall, 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.

Keywords: FOREX Market, Onshore, offshore, China, covered interest rate parity (CIRP)

JEL Classification: F01, F15, F31