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What's on their mind: do exchange rate forecasters stick to theoretical models?

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  • Schröder, Michael
  • Dornau, Robert

Abstract

Do financial market analysts use structural economic models when forecasting exchange rates? This is the leading question analysed in this paper. In contrast to other studies we use expectations data instead of observable variables. Therefore we analyse the implicit structural models forecasters have in mind when forming their exchange rate expectations. The economic exchange rate models included in our study are purchasing power parity, the flexible-price monetary model, the sticky-price monetary model and the Mundell-Fleming model. These models are the theoretical basis for the estimation of latent structural models using the categorical expectations data of the ZEW financial market survey. The expectation variables used to explain expected exchange rates are short term interest rates, long term interest rates and business expectations. Our results show that the flexible-price monetary model is clearly rejected, but the sticky-price monetary model (in case of DM/Pound Sterling and DM/Yen) and the Mundell-Fleming model (in case of DM/US-Dollar) are both compatible with the estimated parameters.

Suggested Citation

  • Schröder, Michael & Dornau, Robert, 1999. "What's on their mind: do exchange rate forecasters stick to theoretical models?," ZEW Discussion Papers 99-08, ZEW - Leibniz Centre for European Economic Research.
    • Handle: RePEc:zbw:zewdip:5222
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    References listed on IDEAS

    as
    1. Isard,Peter, 1995. "Exchange Rate Economics," Cambridge Books, Cambridge University Press, number 9780521466004, November.
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    3. Sarno,Lucio & Taylor,Mark P., 2003. "The Economics of Exchange Rates," Cambridge Books, Cambridge University Press, number 9780521485845, November.
    4. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
    5. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-1176, December.
    6. Isard,Peter, 1995. "Exchange Rate Economics," Cambridge Books, Cambridge University Press, number 9780521460477, November.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Exchange rate modelling; Expectations; Survey data; Categorical Data;
    All these keywords.

    JEL classification:

    • C35 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Discrete Regression and Qualitative Choice Models; Discrete Regressors; Proportions
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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