Market efficiency and apparent unit roots: An application to exchange rates

Prices in efficient markets are influenced by trading based on past pattern s in the series. This induces parameter instability and near-random-walk be haviour in any time-series model of such data. Simulation results suggest t hat this parameter instability makes stationary series more likely To be er roneously classified as nonstationary, according to standard unit root or s tationarity tests. It is shown that individual real exchange rare series ap pear individually non-stationary, especially for tests based on a null of s tationarity, even though they appeal stationary when treated as a panel.