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Further evidence on the rationality of interest rate expectations

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  • Jongen, Ron
  • Verschoor, Willem F.C.

Abstract

This paper extends the limited work on interest rate expectations to a previously unexploited data set that covers a broad range of EMS and non-EMS foreign currency deposits. We corroborate the earlier finding in the literature that interest rate forecasts are not rational and that agents do not use all available information in an efficient manner; this finding applies to the post-1990 period, thus questioning the assertion of Frankel and Froot [Frankel, J.F., Froot, K.A., 1987a. Using survey data to test standard propositions regarding exchange rate expectations. American Economic Review 77, 151] that "the nature of the rejection of rational expectations strongly depends on the sample period". Although forecast errors on EMS rates are smaller and less volatile than errors on non-EMS rates, expectations on EMS rates are nevertheless biased.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of International Financial Markets, Institutions and Money.

Volume (Year): 18 (2008)
Issue (Month): 5 (December)
Pages: 438-448

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Handle: RePEc:eee:intfin:v:18:y:2008:i:5:p:438-448

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Web page: http://www.elsevier.com/locate/intfin

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References

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  1. Jongen, Ron & Verschoor, Willem F C & Wolff, Christian C, 2005. "Time Variation in Term Premia: International Evidence," CEPR Discussion Papers 4959, C.E.P.R. Discussion Papers.
  2. Geert Bekaert & Robert J. Hodrick & David A. Marshall, 1997. ""Peso Problem" Explanations for Term Structure Anomalies," NBER Working Papers 6147, National Bureau of Economic Research, Inc.
  3. Frankel, Jeff & Froot, Ken, 1986. "Using Survey Data to Test Standard Propositions Regarding Exchange Rate Expectations," Department of Economics, Working Paper Series qt1972q8wm, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  4. Taylor, Mark P, 1989. "Expectations, Risk and Uncertainty in the Foreign Exchange Market: Some Results Based on Survey Data," The Manchester School of Economic & Social Studies, University of Manchester, vol. 57(2), pages 142-53, June.
  5. Modigliani, Franco & Shiller, Robert J, 1973. "Inflation, Rational Expectations and the Term Structure of Interest Rates," Economica, London School of Economics and Political Science, vol. 40(157), pages 12-43, February.
  6. Kenneth A. Froot, 1990. "New Hope for the Expectations Hypothesis of the Term Structure of Interest Rates," NBER Working Papers 2363, National Bureau of Economic Research, Inc.
  7. Hafer, R W & Hein, Scott E & MacDonald, S Scott, 1992. "Market and Survey Forecasts of the Three-Month Treasury-Bill Rate," The Journal of Business, University of Chicago Press, vol. 65(1), pages 123-38, January.
  8. Sargent, Thomas J & Wallace, Neil, 1975. ""Rational" Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 241-54, April.
  9. Charles Engel, 1996. "The Forward Discount Anomaly and the Risk Premium: A Survey of Recent Evidence," NBER Working Papers 5312, National Bureau of Economic Research, Inc.
  10. Frankel, Jeffrey A. & Froot, Kenneth A., 1987. "Short-term and long-term expectations of the yen/dollar exchange rate: Evidence from survey data," Journal of the Japanese and International Economies, Elsevier, vol. 1(3), pages 249-274, September.
  11. Cavaglia, Stefano & Verschoor, Willem F. C. & Wolff, Christian C. P., 1993. "Further evidence on exchange rate expectations," Journal of International Money and Finance, Elsevier, vol. 12(1), pages 78-98, February.
  12. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  13. Bera, Anil K. & Jarque, Carlos M., 1982. "Model specification tests : A simultaneous approach," Journal of Econometrics, Elsevier, vol. 20(1), pages 59-82, October.
  14. Benjamin M. Friedman, 1980. "Survey Evidence on The Rationality of Interest Rate Expectations," NBER Working Papers 0261, National Bureau of Economic Research, Inc.
  15. Jeffrey A. Frankel & Kenneth A. Froot, 1987. "Using Survey Data to Test Some Standard Propositions Regarding Exchange Rate Expectations," NBER Working Papers 1672, National Bureau of Economic Research, Inc.
  16. Cavaglia, Stefano M F G & Verschoor, Willem F C & Wolff, Christian C P, 1994. "On the Biasedness of Forward Foreign Exchange Rates: Irrationality or Risk Premia?," The Journal of Business, University of Chicago Press, vol. 67(3), pages 321-43, July.
  17. Friedman, Benjamin M., 1980. "Survey evidence on the `rationality' of interest rate expectations," Journal of Monetary Economics, Elsevier, vol. 6(4), pages 453-465, October.
  18. Friedman, Benjamin M, 1979. "Interest Rate Expectations versus Forward Rates: Evidence from an Expectations Survey," Journal of Finance, American Finance Association, vol. 34(4), pages 965-73, September.
  19. Cavaglia Stefano & Verschoor Willem F. C. & Wolff Christian C. P., 1993. "Asian Exchange Rate Expectations," Journal of the Japanese and International Economies, Elsevier, vol. 7(1), pages 57-77, March.
  20. Kathryn M. Dominguez, 1986. "Are foreign exchange forecasts rational? New evidence from survey data," International Finance Discussion Papers 281, Board of Governors of the Federal Reserve System (U.S.).
  21. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  22. Barro, Robert J., 1976. "Rational expectations and the role of monetary policy," Journal of Monetary Economics, Elsevier, vol. 2(1), pages 1-32, January.
  23. Frederick Nieuwland & Willem Verschoor & Christian Wolff, 2000. "Exchange risk premia in the European monetary system," Applied Financial Economics, Taylor & Francis Journals, vol. 10(4), pages 351-360.
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Cited by:
  1. Smant, David / D.J.C., 2010. "Direct tests of the expectations theory of the term structure: Survey expectations, the term premium and coefficient biases," MPRA Paper 19815, University Library of Munich, Germany.
  2. Chortareas, Georgios & Jitmaneeroj, Boonlert & Wood, Andrew, 2012. "Forecast rationality and monetary policy frameworks: Evidence from UK interest rate forecasts," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 22(1), pages 209-231.

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