A loop diagram pedagogy: seeing the unseen in the forward market efficiency hypothesis

Abstract

Purpose – In an introductory finance course, business school students often report difficulty in dealing with several variables and regression equations in testing the forward market efficiency and its relevant hypotheses: forward rate unbiasedness, rational expectations, risk neutrality and homogeneous expectations. The paper aims to discuss these issues. Design/methodology/approach – Although each of these hypotheses may be relatively easy to understand one by one, it is harder to see their linkages. Thus, the author develops the loop diagram for supplementing traditional instruction methods. Findings – The author finds that a significant majority of students prefer the loop diagram approach. Furthermore, students using loop diagram display more understanding of the forward market efficiency than those with access to a conventional instruction. Originality/value – The loop diagram provides students a simple visual aid for formulating a complete set of regressions and enables them to analyze a richer set of relationships between several hypotheses than what they typically see in finance textbooks.