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Investor sentiment in the US-dollar: longer-term, nonlinear orientation on PPP

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Author Info
Menkhoff, Lukas
Rebitzky, Rafael

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Abstract

How is it possible that exchange rates move in the long run towards fundamentals, while professionals form consistently irrational exchange rate expectations? We look at this puzzle from a different perspective by analyzing investor sentiment in the US-dollar market. First, long-horizon regressions show that investor sentiment is connected with exchange rate returns at longer horizons, i.e. more than two years. Second, sentiment is cointegrated with fundamentals, whereas third, this relation becomes stronger, the larger exchange rate's misalignment from long-run PPP. In sum, investor sentiment's behavior in the US-dollar market closely matches with established facts of empirical exchange rate research.

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Paper provided by Universität Hannover, Wirtschaftswissenschaftliche Fakultät in its series Diskussionspapiere der Wirtschaftswissenschaftlichen Fakultät der Universität Hannover with number dp-376.

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Length: 28 pages
Date of creation: Sep 2007
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Handle: RePEc:han:dpaper:dp-376

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Keywords: Exchange rates investor sentiment long-horizon regression threshold VECM

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Find related papers by JEL classification:
F31 - International Economics - - International Finance - - - Foreign Exchange
G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies

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