An Investigation of Foreign Exchange Market Efficiency

Madiha Fayyaz; Abida Yousaf

doi:10.54938/ijemd-ss.2026.05.6.904

Authors

Madiha Fayyaz International Institute of Islamic Economics (IIIE), IIU, Islamabad, Pakistan
Abida Yousaf International Institute of Islamic Economics (IIIE), IIU, Islamabad, Pakistan

DOI:

https://doi.org/10.54938/ijemd-ss.2026.05.6.904

Keywords:

Foreign exchange efficiency, Multifractal detrended fluctuation analysis (MF-DFA), Generalized Hurst exponents, Singularity spectrum, South Asian economies, Adaptive market hypothesis

Abstract

In this paper, we investigate the market efficiency and scaling dynamics of foreign exchange market efficiency. The daily exchange rate return series of the four countries of South Asia, namely Bangladesh, India, Pakistan and Sri Lanka are used. We used the Multifractal Detrended Fluctuation Analysis (MFDFA) to examine the non-linear dynamics of the FX market. MFDFA can investigate non-linear trends , market anomalies, and heterogeneous patterns in asset prices. Our findings suggest the departure from the traditional framework of Efficient Market Hypothesis (EMH). The empirical findings from the four markets are contrary to the weak-form random walk theory. In this regard, it indicates that the foreign exchange rate's volatility is anti persistent in nature and hold mean reverting price dynamics. Moreover, comparative analysis shows a distinct regional hierarchy of nonlinear market complexity. Bangladesh currency market exhibits a higher degree of inefficiency and spectrum width. Credit control and foreign exchange rationing is the reason for the highest degree in Bangladesh. The multifractal spectrum for Sri Lanka is very steep and there is a very steep singularity expansion at the end. It implies that the localized dynamics of the jumps are related to structural regime change and the sovereign debt crisis in Sri Lanka. The results of India demonstrate superior power law and managed scaling complexity. The compressed singularity spectrum for Pakistan is a policy induced phenomenon, which has been brought about by the price control by the central bank. The overall results of this study indicate that the adaptive market hypothesis is valid. So, discretionary interventions and liquidity constraints throw off the natural balance from the market.

Downloads

Download data is not yet available.

References

[1] Aslam, F., Aziz, S., Nguyen, D. K., Mughal, K. S., & Khan, M. (2020). On the efficiency of foreign exchange markets in times of the COVID-19 pandemic. Technological Forecasting and Social Change, 161, Article 120261. https://doi.org/10.1016/j.techfore.2020.120261

[2] Akin, I., & Akin, M. (2026). Behavioral finance impacts on US stock market volatility: An analysis of market anomalies. Behavioural Public Policy, 10(2), 337–361.

[3] Bertelsmann Stiftung. (2024). BTI 2024 country report: Sri Lanka. Bertelsmann Stiftung.

[4] Central Bank of Sri Lanka [CBSL]. (2026). Market operations report – June 2026. Central Bank of Sri Lanka.

[5] Christodoulou-Volos, C. (2025). The impact of temporal aggregation on nonlinearity detection: An empirical analysis of exchange rate dynamics using the LM test. Edelweiss Applied Science and Technology, 9(7), 918–936.

[6] Datta, R. P. (2024). Analysis of Indian foreign exchange markets: A multifractal detrended fluctuation analysis (MFDFA) approach. International Journal of Empirical Economics, 3(3). https://doi.org/10.1142/S2810943024500069

[7] Diniz-Maganini, N., Rasheed, A. A., & Sheng, H. H. (2021). Exchange rate regimes and price efficiency. Journal of International Financial Markets, Institutions and Money, 73, Article 101361. https://doi.org/10.1016/j.intfin.2021.101361

[8] Diniz-Maganini, N., Rasheed, A. A., & Sheng, H. H. (2023). Price efficiency of the foreign exchange rates of BRICS countries. Latin American Journal of Central Banking, 4(4), Article 100081. https://doi.org/10.1016/j.latcb.2023.100081

[9] Dissanayaka, U. (2024). Twin deficit hypothesis: The case of Sri Lanka (Master's report, University of New Brunswick). UNB Scholar.

[10] Dutta, S., Ghosh, D., & Chatterjee, S. (2016). Multifractal detrended cross-correlation analysis of foreign exchange and SENSEX fluctuation in Indian perspective. Physica A: Statistical Mechanics and its Applications, 463, 188–201. https://doi.org/10.1016/j.physa.2016.07.027

[11] Fama, E. F. (1970). Efficient capital markets: A review of theory and empirical work. The Journal of Finance, 25(2), 383–417. https://doi.org/10.2307/2325486

[12] Han, C., Wang, Y., & Xu, Y. (2020). Nonlinearity and efficiency dynamics of foreign exchange markets: Evidence from multifractality and volatility of major exchange rates. Economic Research-Ekonomska Istraživanja, 33(1), 731–751. https://doi.org/10.1080/1331677X.2020.1734852

[13] Jabeen, M., & Ahmed, U. (2015). Exchange rate volatility and market efficiency: Evidence from Pakistan. AIUB Journal of Business and Economics, 12(1), 70–92.

[14] Jayasekara, M. (2022). An analysis of exchange rate pass-through and impact on domestic inflation in Sri Lanka. Indian Journal of Economics and Financial Issues, 3(1), 1–31.

[15] Kantelhardt, J. W., Zschiegner, S. A., Koscielny-Bunde, E., Havlin, S., Bunde, A., & Stanley, H. E. (2002). Multifractal detrended fluctuation analysis of nonstationary time series. Physica A: Statistical Mechanics and its Applications, 316(1–4), 87–114. https://doi.org/10.1016/S0378-4371(02)01383-8

[16] Makovský, P. (2021). Is the Market Efficiency Hypothesis applicable in the Czech Republic – FOREX case. Universal Journal of Accounting and Finance, 9(6), 1495–1502. https://doi.org/10.13189/ujaf.2021.090626

[17] Mandelbrot, B. (1963). The variation of certain speculative prices. The Journal of Business, 36(4), 394–419.

[18] Müller, U. A., Dacorogna, M. M., Davé, R. D., Olsen, R. B., Pictet, O. V., & von Weizsäcker, J. E. (1997). Volatility of foreign exchange markets: A study of magnifying effects. Journal of Empirical Finance, 4(2–3), 213–239. https://doi.org/10.1016/S0927-5398(97)00008-0

[19] Olufemi, A. P., Adewale, A. O., & Oseko, M. S. (2017). Efficiency of foreign exchange markets in sub-Saharan Africa in the presence of structural break: A linear and non-linear testing approach. Journal of Economics and Behavioral Studies, 9(4), 122–131.

[20] Peters, E. E. (1994). Fractal market analysis: Applying chaos theory to investment and economics. John Wiley & Sons.

[21] Rathnayake, G. I. (2018). Effect of exchange rate volatility on Sri Lanka's inbound tourist flow. Central Bank of Sri Lanka Staff Studies, 48(2), 25–68.

[22] Raza, S. A., Shah, N., & Suleman, M. T. (2024). A multifractal detrended fluctuation analysis of Islamic and conventional financial markets efficiency during the COVID-19 pandemic. International Economics, 177, Article 100463. https://doi.org/10.1016/j.inteco.2023.100463

[23] Rothschild & Co. (2024). Important innovations in sovereign finance: The arrival of Macro-Linked Bonds (MLBs) and Governance-Linked Bonds (GLBs). Rothschild & Co Insights.

[24] Shrestha, K., Naysary, B., & Philip, S. S. S. (2023). Fintech market efficiency: A multifractal detrended fluctuation analysis. Finance Research Letters, 54, Article 103775. https://doi.org/10.1016/j.frl.2023.103775

[25] Vigato, A. (2025). Sri Lanka: After the storm, a promising economic recovery (MacroDev No. 128). Éditions AFD.

[26] World Bank. (2024). Sri Lanka Development Update: Opening Up to the Future. World Bank Group.

[27] Zhang, W., & Huang, Z. (2025). Nonlinear dynamics of RMB exchange rate volatility: A multifractal perspective within the G-expectation framework. Fractal and Fractional, 9(11), 746.