Foreign exchange market inefficiency and exchange rate anomalies

This paper develops a perfectly general non-linear Uncovered Interest Parity, UIP, framework with foreign exchange (fx) market inefficiency. The latter means that there is always some “unexploited profit” which tends to generate a negative value for Fama's beta coefficient. However, as ID decays over time, this tends to generate a positive value for beta. The sign of beta is uncertain. It is shown that this result implies that the existence of fx market inefficiency is consistent with many puzzling facts about exchange rates, and that the model's implied values for beta are consistent with those obtained via actual data.