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Rational Expectations and the Foreign Exchange Market

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  • Peter R. Hartley

Abstract

Many models of exchange rate determination imply that movements in money supplies and demands should result in movements in exchange rates. Hence, if rational agents are attempting to forecast exchange rate movements, they should in the first instance forecast movements in the supplies of and demands for money balances. Furthermore, if these underlying variables follow some stable autoregressive processes agents should use those processes to make their forecasts. If we identify the forward rate with the market's expectation for the future spot rate, rationality of expectations will imply testable cross-equation restrictions in a joint model of the autoregressions and exchange rate forecasting equation. This strategy is implemented in the paper using data on the L UK/$US and DM/$US exchange rates from the recent floating rate period.

Suggested Citation

  • Peter R. Hartley, 1982. "Rational Expectations and the Foreign Exchange Market," NBER Working Papers 0863, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:0863
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    1. Oliinyk Oksana & Ksendzuk Valentyna & Sergiienko Larysa & Lehan Iryna, 2020. "Research Of Functional Changes In Foreign Exchange Rate EUR/UAH Under Conditions Of Economic Transformation In Ukraine," Bulletin of Geography. Socio-economic Series, Sciendo, vol. 48(48), pages 141-154, June.
    2. Sebastian Edwards, 1981. "Floating Excahnge Rates, Exectations and New Information," UCLA Economics Working Papers 227, UCLA Department of Economics.
    3. Edwards, Sebastian, 1983. "Floating exchange rates, expectations and new information," Journal of Monetary Economics, Elsevier, vol. 11(3), pages 321-336.
    4. Thomas C. Glaessner, 1982. "Formulation and estimation of a dynamic model of exchange rate determination: an application of general method of moments techniques," International Finance Discussion Papers 208, Board of Governors of the Federal Reserve System (U.S.).

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