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The scapegoat theory of exchange rates: the first tests

Author

Listed:
  • Marcel Fratzscher

    (DIW Berlin and Humboldt University)

  • Dagfinn Rime

    (BI Norwegian Business School)

  • Lucio Sarno

    (Cass Business School)

  • Gabriele Zinna

    (Bank of Italy)

Abstract

The scapegoat theory of exchange rates (Bacchetta and van Wincoop 2004, 2013) suggests that market participants may attach excessive weight to individual economic fundamentals, which are picked as scapegoats to rationalize observed currency fluctuations at times when exchange rates are driven by unobservable shocks. Using novel survey data that directly measure foreign exchange scapegoats for 12 exchange rates, we find empirical evidence that supports the scapegoat theory. The resulting models explain a large fraction of the variation and directional changes in exchange rates in sample, although their out-of-sample forecasting performance is mixed.

Suggested Citation

  • Marcel Fratzscher & Dagfinn Rime & Lucio Sarno & Gabriele Zinna, 2014. "The scapegoat theory of exchange rates: the first tests," Temi di discussione (Economic working papers) 991, Bank of Italy, Economic Research and International Relations Area.
    • Handle: RePEc:bdi:wptemi:td_991_14
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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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