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Do Dollar Forecasters Believe too Much in PPP?

  • Menkhoff, Lukas
  • Rebitzky, Rafael
  • Schröder, Michael

This paper extends earlier studies on exchange rate expectations' formation by using new data and adding information about forecasters' reliance on fundamental analysis for the first time. We replicate the conventional result of non rational expectations. Moreover, biases in expectations are identified as professionals significantly belief too much in mean reversion, mean being represented by PPP. When respondents are grouped on their reliance to fundamental analysis, fundamentalists reveal an even stronger bias. Those, who rely the least on fundamentals preferring technical analysis instead , show a significantly smaller bias towards PPP in lieu of expecting too much trend extrapolation. Biased beliefs will grow stronger when the US Dollar is further away from PPP. Finally, the accuracy of the expectations is poor for both groups however we find directional forecasting ability.

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Paper provided by Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät in its series Hannover Economic Papers (HEP) with number dp-321.

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Length: 21 pages
Date of creation: Sep 2005
Date of revision:
Handle: RePEc:han:dpaper:dp-321
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  1. Mark P. Taylor, 1995. "The Economics of Exchange Rates," Journal of Economic Literature, American Economic Association, vol. 33(1), pages 13-47, March.
  2. Alan M. Taylor & Mark P. Taylor, 2004. "The Purchasing Power Parity Debate," NBER Working Papers 10607, National Bureau of Economic Research, Inc.
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  6. Menkhoff, Lukas & Schmidt, Ulrich, 2005. "The Use of Trading Strategies by Fund Managers: Some First Survey Evidence," Hannover Economic Papers (HEP) dp-314, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
  7. 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 829-53, October.
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  17. Taylor, Mark P, 1989. "Expectations, Risk and Uncertainty in the Foreign Exchange Market: Some Results Based on Survey Data," The Manchester School of Economic & Social Studies, University of Manchester, vol. 57(2), pages 142-53, June.
  18. MacDonald, Ronald, 2000. " Expectations Formation and Risk in Three Financial Markets: Surveying What the Surveys Say," Journal of Economic Surveys, Wiley Blackwell, vol. 14(1), pages 69-100, February.
  19. Kathryn M. Dominguez, 1986. "Are foreign exchange forecasts rational? New evidence from survey data," International Finance Discussion Papers 281, Board of Governors of the Federal Reserve System (U.S.).
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