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On the consistency of short-run and long-run exchange rate expectations

  • Froot, Kenneth A.
  • Ito, Takatoshi

This paper examines whether short-term exchange rate expectations move "too much" by comparing them with long-term expectations. We develop a set of nonlinear restrictions linking expectations at different forecast horizons. The restrictions impose consistency, a property weaker than rationality. We use ex- change rate survey data to measure expectations and then test whether consistency holds. The data show that a current, positive exchange rate shock leads agents to expect a higher long-run future spot rate when iterating forward their short-term expectations than when thinking directly about the long run. In this sense short-horizon expectations may overreact to current exchange rate changes.

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Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 8 (1989)
Issue (Month): 4 (December)
Pages: 487-510

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Handle: RePEc:eee:jimfin:v:8:y:1989:i:4:p:487-510
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30443

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  1. Huizinga, John, 1987. "An empirical investigation of the long-run behavior of real exchange rates," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 27(1), pages 149-214, January.
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  3. Rubinstein, Mark, 1974. "An aggregation theorem for securities markets," Journal of Financial Economics, Elsevier, vol. 1(3), pages 225-244, September.
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  8. Paul R. Krugman, 1985. "Is the Strong Dollar Sustainable?," NBER Working Papers 1644, National Bureau of Economic Research, Inc.
  9. 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.
  10. Hodrick, Robert J., 1989. "Risk, uncertainty, and exchange rates," Journal of Monetary Economics, Elsevier, vol. 23(3), pages 433-459, May.
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  13. Sargent, Thomas J., 1979. "A note on maximum likelihood estimation of the rational expectations model of the term structure," Journal of Monetary Economics, Elsevier, vol. 5(1), pages 133-143, January.
  14. Dominguez, Kathryn M., 1986. "Are foreign exchange forecasts rational? : New evidence from survey data," Economics Letters, Elsevier, vol. 21(3), pages 277-281.
  15. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
  16. Maurice Obstfeld, 1987. "Peso Problems, Bubbles, and Risk in the Empirical Assessment of Exchange-Rate Behavior," NBER Working Papers 2203, National Bureau of Economic Research, Inc.
  17. J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1987. "The Economic Consequences of Noise Traders," NBER Working Papers 2395, National Bureau of Economic Research, Inc.
  18. Blanchard, Olivier Jean, 1979. "Speculative bubbles, crashes and rational expectations," Economics Letters, Elsevier, vol. 3(4), pages 387-389.
  19. 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.
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