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Sticking to Their Guns: Short-Horizon Exchange Rate Expectations

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  • Kremens, Lukas
  • Varela, Liliana

Abstract

Short-horizon exchange rate forecasts systematically - and incorrectly - predict a partial reversal of their previous errors, both in consensus and forecaster-by-forecaster measures. This pattern spans almost two-thirds (two-fifths) of the variation in consensus (individual) forecasts and explains their poor predictive performance at short horizons. We decompose short-term forecasts into three orthogonal components correlated with (i) long-term forecasts, (ii) past errors, and (iii) residual noise. The first two components account for three-quarters of forecast variance and strongly predict realizations. But the error-loading component predicts in the wrong direction, offsetting predictive information in the long-term component, and renders the overall forecast uninformative.

Suggested Citation

  • Kremens, Lukas & Varela, Liliana, 2026. "Sticking to Their Guns: Short-Horizon Exchange Rate Expectations," CEPR Discussion Papers 21258, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:21258
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    File URL: https://cepr.org/publications/DP21258
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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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