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Expectation formation in the foreign exchange market: a time-varying heterogeneity approach using survey data

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  • Georges Prat
  • Remzi Uctum

Abstract

Using Consensus Economics survey data on JPY/USD and GBP/USD exchange rate expectations for the 3- and 12-month horizons over the period November 1989 – December 2012 we first show that expectations fail to unbiasedness tests and do not exhibit a learning process towards rationality. Our approach is consistent with the economically rational expectations theory (Feige and Pearce, 1976), which states that information costs and agents’ aversion of misestimating future exchange rates determine the optimal amounts of information on which they base their expectations. The time-variability of the cost/aversion ratios justifies at the aggregate level a representation of expectations as a linear combination of the traditional extrapolative, adaptive and regressive processes augmented by a forward market component, whose parameters are allowed to change over time. This mixed expectation model with unstable heterogeneity is validated by our Kalman Filter estimation results for the two currencies and the two horizons considered. Although the chartist behavior, gathering the extrapolative and adaptive components, appears to dominate the fundamentalist behavior, described by the regressive and forward market components, the relative importance of the fundamentalists (chartists) is found to increase (decrease) with the time-horizon.

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  • 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.
  • Handle: RePEc:drm:wpaper:2014-17
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    2. Georges Prat & Remzi Uctum, 2016. "Do markets learn to rationally expect US interest rates? Evidence from survey data," Post-Print hal-01411824, HAL.
    3. repec:ipg:wpaper:2014-576 is not listed on IDEAS
    4. repec:ipg:wpaper:2014-564 is not listed on IDEAS
    5. Cifarelli, Giulio & Paladino, Giovanna, 2018. "Can the interaction between a single long-term attractor and heterogeneous trading explain exchange rate behaviour? A nonlinear econometric investigation," MPRA Paper 83894, University Library of Munich, Germany.
    6. repec:ipg:wpaper:2014-574 is not listed on IDEAS
    7. Cifarelli, Giulio & Paladino, Giovanna, 2018. "Can the interaction between a single long-term attractor and heterogeneous trading explain the exchange rate conundrum?," Research in International Business and Finance, Elsevier, vol. 46(C), pages 313-323.
    8. repec:ipg:wpaper:2014-550 is not listed on IDEAS
    9. repec:ipg:wpaper:2014-531 is not listed on IDEAS
    10. Saskia ter Ellen & Willem F. C. Verschoor, 2018. "Heterogeneous Beliefs and Asset Price Dynamics: A Survey of Recent Evidence," Dynamic Modeling and Econometrics in Economics and Finance, in: Fredj Jawadi (ed.), Uncertainty, Expectations and Asset Price Dynamics, pages 53-79, Springer.
    11. Imane El Ouadghiri, 2015. "Heterogeneity in Macroeconomic News Expectations: A disaggregate level analysis," EconomiX Working Papers 2015-17, University of Paris Nanterre, EconomiX.
    12. Beckmann, Joscha & Czudaj, Robert L., 2022. "The role of expectations for currency crisis dynamics - the case of the Turkish lira," MPRA Paper 114963, University Library of Munich, Germany.

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    More about this item

    Keywords

    expectation formation; exchange rates; dynamic heterogeneity; survey data.;
    All these keywords.

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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