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Switching between Expectation Processes in the Foreign Exchange Market: a Probabilistic Approach using Survey Data

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  • Georges Prat
  • Remzi Uctum

Abstract

This paper relaxes a fundamental hypothesis commonly accepted in the expectation formation literature: expectations are, unchangingly, either rational or generated by one of the three simple extrapolative, regressive, or adaptive processes. Using expectations survey data provided by Consensus Forecasts on six European exchange rates against the US dollar, we find that the rational expectations hypothesis is rejected at the aggregate level. By implementing a switching-regression methodology with stochastic choice of regime, we show that the expectation generating process is given at any time by some combination of the three simple processes. An interpretation of this framework in terms of economically rational expectations is suggested. Copyright © 2007 The Authors; Journal compilation © 2007 Blackwell Publishing Ltd.

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  • Georges Prat & Remzi Uctum, 2007. "Switching between Expectation Processes in the Foreign Exchange Market: a Probabilistic Approach using Survey Data," Review of International Economics, Wiley Blackwell, vol. 15(4), pages 700-719, September.
  • Handle: RePEc:bla:reviec:v:15:y:2007:i:4:p:700-719
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    1. Reinhart, Carmen & Calvo, Guillermo, 1999. "Inversión de las corrientes de capital, tipo de cambio y dolarización
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    7. Hutchison, Michael & McDill, Kathleen, 1999. "Are All Banking Crises Alike? The Japanese Experience in International Comparison," Journal of the Japanese and International Economies, Elsevier, pages 155-180.
    8. Weymark, Diana N., 1995. "Estimating exchange market pressure and the degree of exchange market intervention for Canada," Journal of International Economics, Elsevier, pages 273-295.
    9. Michael Hutchison, 2003. "A Cure Worse Than the Disease? Currency Crises and the Output Costs of IMF-Supported Stabilization Programs," NBER Chapters,in: Managing Currency Crises in Emerging Markets, pages 321-360 National Bureau of Economic Research, Inc.
    10. Chinn, Menzie D. & Dooley, Michael P. & Shrestha, Sona, 1999. "Latin America and East Asia in the context of an insurance model of currency crises," Journal of International Money and Finance, Elsevier, vol. 18(4), pages 659-681, August.
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    Cited by:

    1. Georges Prat & Remzi Uctum, 2014. "Expectation formation in the foreign exchange market: a time-varying heterogeneity approach using survey data," EconomiX Working Papers 2014-17, University of Paris Nanterre, EconomiX.
    2. Prat, Georges & Uctum, Remzi, 2011. "Modelling oil price expectations: Evidence from survey data," The Quarterly Review of Economics and Finance, Elsevier, vol. 51(3), pages 236-247, June.
    3. Uctum, Remzi, 2007. "Économétrie des modèles à changement de régimes : un essai de synthèse," L'Actualité Economique, Société Canadienne de Science Economique, vol. 83(4), pages 447-482, décembre.
    4. Prat, Georges & Uctum, Remzi, 2013. "Modeling the horizon-dependent ex-ante risk premium in the foreign exchange market: Evidence from survey data," Journal of International Financial Markets, Institutions and Money, Elsevier, pages 33-54.
    5. Georges Prat & Remzi Uctum, 2012. "Modeling the horizon-dependent risk premium in the forex market: evidence from survey data," EconomiX Working Papers 2012-29, University of Paris Nanterre, EconomiX.
    6. Neslihan Topbas, 2014. "Tests of Rationality in Turkish Foreign Exchange Market," Central Bank Review, Research and Monetary Policy Department, Central Bank of the Republic of Turkey, vol. 14(2), pages 65-78.
    7. Jongen, Ron & Verschoor, Willem F.C. & Wolff, Christian C.P. & Zwinkels, Remco C.J., 2012. "Explaining dispersion in foreign exchange expectations: A heterogeneous agent approach," Journal of Economic Dynamics and Control, Elsevier, vol. 36(5), pages 719-735.
    8. ter Ellen, Saskia & Verschoor, Willem F.C. & Zwinkels, Remco C.J., 2013. "Dynamic expectation formation in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 37(C), pages 75-97.
    9. Imane El Ouadghiri, 2015. "Heterogeneity in Macroeconomic News Expectations: A disaggregate level analysis," EconomiX Working Papers 2015-17, University of Paris Nanterre, EconomiX.

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