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Should One Rely on Professional Exchange Rate Forecasts? An Empirical Analysis of Professional Forecasts for the €/US$ Rate

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  • Bofinger, Peter
  • Schmidt, Robert
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    Abstract

    The study analyses the characteristics of professional exchange rate forecasts for the €/US$ rate. The results indicate that the quality of forecasts produced by professional economists is rather poor and incompatible with the rational expectations hypothesis. This dismal result is according to our analysis attributed to the fact that professional forecasts are to a large extent influenced by actual changes in exchange rates. A reasonable explanation for this behaviour can be derived from the behavioural finance literature. According to the anchoring heuristic, decision processes are often dominated by available pieces of information even if they are obviously of no relevance.

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    Bibliographic Info

    Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4235.

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    Date of creation: Feb 2004
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    Handle: RePEc:cpr:ceprdp:4235

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    Related research

    Keywords: anchoring heuristic; behavioural finance; forecasts; foreign exchange market; rational expectations;

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    References

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    1. Francis X. Diebold & Jose A. Lopez, 1995. "Forecast evaluation and combination," Research Paper 9525, Federal Reserve Bank of New York.
    2. Jeffrey A. Frankel & Kenneth A. Froot, 1985. "Using Survey Data to Test Some Standard Propositions Regarding Exchange Rate Expectations," NBER Working Papers 1672, 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, Department of Economics, Institute for Business and Economic Research, UC Berkeley qt1972q8wm, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
    4. Froot, Kenneth A. & Frankel, Jeffrey A., 1988. "Forward Discount Bias: Is It an Exchange Risk Premium?," Department of Economics, Working Paper Series, Department of Economics, Institute for Business and Economic Research, UC Berkeley qt5w65g4zg, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
    5. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
    6. 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.
    7. Hansen, Lars Peter & Hodrick, Robert J, 1980. "Forward Exchange Rates as Optimal Predictors of Future Spot Rates: An Econometric Analysis," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 88(5), pages 829-53, October.
    8. Schmidt, Robert, 2003. "Zur Qualität professioneller Wechselkursprognosen," W.E.P. - Würzburg Economic Papers 36, University of Würzburg, Chair for Monetary Policy and International Economics.
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    Cited by:
    1. Beber, Alessandro & Breedon, Francis & Buraschi, Andrea, 2010. "Differences in beliefs and currency risk premiums," Journal of Financial Economics, Elsevier, Elsevier, vol. 98(3), pages 415-438, December.

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