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Testing the Rationality of Exchange Rate and Interest Rate Expectations: An Empirical Study of Australian Survey Based Expectations

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  • Kim, Suk-Joong

Abstract

This paper examines the rationality and optimality of the survey based expectations of Australian exchange rate and interest rates. One and four week ahead forecast of USD/$A exchange rate and two and four week ahead forecasts of the 190-day bank bill and l0-year bond rates were examined. The actual and expected variables were found to be cointegrated which indicates that the expected future values and the future realisations of the exchange rate and interest rates have long run equilibrium relationships. Estimation techniques that take into account the time-varying nature of the forecast error variance and the linear serial correlation in the form of moving average errors were employed for testing the optimality of the expectations in the cases where the frequency of the expectations data were finer than the forecast horizons. The estimation results show that the rationality of the expectations could not be rejected for all the expectations with the exception of the two week ahead forecast of the 90-day interest rate, which indicates that all available information was used at the time of forming relevant forecasts. The optimality of the expectations as tested through the Unbiased Expectations Hypothesis, is decisively rejected in all cases.

Suggested Citation

  • Kim, Suk-Joong, 1996. "Testing the Rationality of Exchange Rate and Interest Rate Expectations: An Empirical Study of Australian Survey Based Expectations," Working Papers 230, University of Sydney, School of Economics.
    • Handle: RePEc:syd:wpaper:2123/6735
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    Cited by:

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    2. Prat, Georges & Uctum, Remzi, 2021. "Term structure of interest rates: Modelling the risk premium using a two horizons framework," Journal of Economic Behavior & Organization, Elsevier, vol. 182(C), pages 421-436.
    3. Ron Jongen & Willem F.C. Verschoor & Christian C.P. Wolff, 2008. "Foreign Exchange Rate Expectations: Survey And Synthesis," Journal of Economic Surveys, Wiley Blackwell, vol. 22(1), pages 140-165, February.
    4. Anastasiou, Dimitrios, 2020. "Senior bank loan officers' expectations for loan demand: Evidence from the Euro-area," MPRA Paper 98903, University Library of Munich, Germany.
    5. Lukas Menkhoff & Rafael Rebitzky & Michael Schroder, 2008. "Do dollar forecasters believe too much in PPP?," Applied Economics, Taylor & Francis Journals, vol. 40(3), pages 261-270.
    6. Chin-Hong Puah & Shirly Siew-Ling Wong & Venus Khim-Sen Liew, 2013. "Testing rational expectations hypothesis in the manufacturing sector in Malaysia," Journal of Business Economics and Management, Taylor & Francis Journals, vol. 14(2), pages 303-316, April.
    7. Chortareas, Georgios & Jitmaneeroj, Boonlert & Wood, Andrew, 2012. "Forecast rationality and monetary policy frameworks: Evidence from UK interest rate forecasts," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 22(1), pages 209-231.
    8. Hogan, Warren P. & Batten, Jonathan A., 2005. "Informed and uninformed trading on the Australian dollar," International Review of Financial Analysis, Elsevier, vol. 14(1), pages 61-75.

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