Working Paper: NBER ID: w2216
Authors: Jeffrey A. Frankel; Kenneth A. Froot
Abstract: Three surveys of exchange rate expectations allow us to measure directly the expected rates of return on yen versus dollars. Expectations of yen appreciation against the dollar have been (1) consistently large, (2) variable, and (3) greater than the forward premium, implying that investors were willing to accept a lower expected return on dollar assets. At short-term horizons expectations exhibit bandwagon effects, while at longer-term horizons they show the reverse. A 10 percent yen appreciation generates the expectation of a further appreciation of 2.4 percent over the following week, for example, but a depreciation of 3.4 percent over the following year. At any horizon, investors would do better to reduce the absolute magnitude of expected depreciation. The true spot rate process behaves more like a random walk.
Keywords: exchange rate expectations; yen-dollar exchange rate; survey data; investor behavior; market dynamics
JEL Codes: F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| expected depreciation (D25) | forward discount (G13) |
| 10% appreciation of the yen (F31) | 2.11% expectation of further appreciation (G19) |
| 3.1% depreciation (E20) | expectation of depreciation over the following year (D25) |
| expectations formation (D84) | biased expectations (D91) |
| contemporaneous and lagged variables (C32) | expectations formation (D84) |
| forward discount (G13) | risk premiums (G19) |