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Should One Rely on Professional Exchange Rate Forecasts? An Empirical Analysis of Professional Forecasts for the €/US$ Rate

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  • Bofinger, Peter
  • Schmidt, Robert

Abstract

The study analyses the characteristics of professional exchange rate forecasts for the €/US$ rate. The results indicate that the quality of forecasts produced by professional economists is rather poor and incompatible with the rational expectations hypothesis. This dismal result is according to our analysis attributed to the fact that professional forecasts are to a large extent influenced by actual changes in exchange rates. A reasonable explanation for this behaviour can be derived from the behavioural finance literature. According to the anchoring heuristic, decision processes are often dominated by available pieces of information even if they are obviously of no relevance.

Suggested Citation

  • Bofinger, Peter & Schmidt, Robert, 2004. "Should One Rely on Professional Exchange Rate Forecasts? An Empirical Analysis of Professional Forecasts for the €/US$ Rate," CEPR Discussion Papers 4235, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:4235
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    References listed on IDEAS

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    1. Hansen, Lars Peter & Hodrick, Robert J, 1980. "Forward Exchange Rates as Optimal Predictors of Future Spot Rates: An Econometric Analysis," Journal of Political Economy, University of Chicago Press, vol. 88(5), pages 829-853, October.
    2. Kenneth A. Froot & Jeffrey A. Frankel, 1989. "Forward Discount Bias: Is it an Exchange Risk Premium?," The Quarterly Journal of Economics, Oxford University Press, vol. 104(1), pages 139-161.
    3. Frankel, Jeffrey A & Froot, Kenneth A, 1987. "Using Survey Data to Test Standard Propositions Regarding Exchange Rate Expectations," American Economic Review, American Economic Association, vol. 77(1), pages 133-153, March.
    4. Francis X. Diebold & Jose A. Lopez, 1995. "Forecast evaluation and combination," Research Paper 9525, Federal Reserve Bank of New York.
    5. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
    6. Cavaglia, Stefano M F G & Verschoor, Willem F C & Wolff, Christian C P, 1994. "On the Biasedness of Forward Foreign Exchange Rates: Irrationality or Risk Premia?," The Journal of Business, University of Chicago Press, vol. 67(3), pages 321-343, July.
    7. 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.
    8. Schmidt, Robert, 2003. "Zur Qualität professioneller Wechselkursprognosen," W.E.P. - Würzburg Economic Papers 36, University of Würzburg, Chair for Monetary Policy and International Economics.
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    Citations

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    Cited by:

    1. Timo WOLLMERSHAEUSER & Robert SCHMIDT, "undated". "Sterilized Foreign Exchange Market Interventions in a Chartist-Fundamentalist Exchange Rate Model," EcoMod2004 330600162, EcoMod.
    2. Leitner, Johannes & Schmidt, Robert & Bofinger, Peter, 2003. "Biases of professional exchange rate forecasts: Psychological explanations and an experimentally based comparison to novices," W.E.P. - Würzburg Economic Papers 39, University of Würzburg, Chair for Monetary Policy and International Economics.
    3. Stephan Schulmeister, 2008. "Components of the profitability of technical currency trading," Applied Financial Economics, Taylor & Francis Journals, vol. 18(11), pages 917-930.
    4. Beber, Alessandro & Breedon, Francis & Buraschi, Andrea, 2010. "Differences in beliefs and currency risk premiums," Journal of Financial Economics, Elsevier, vol. 98(3), pages 415-438, December.
    5. Ravi Balakrishnan & Stefan Laseen & Andrea Pescatori, 2016. "U.S. Dollar Dynamics; How Important Are Policy Divergence and FX Risk Premiums?," IMF Working Papers 16/125, International Monetary Fund.

    More about this item

    Keywords

    anchoring heuristic; behavioural finance; forecasts; foreign exchange market; rational expectations;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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