Working Paper: NBER ID: w2577
Authors: Kenneth A. Froot; Takatoshi Ito
Abstract: This paper examines whether short-term exchange rate expectations move "too much" by comparing them with long-term expectations. We develop a set of nonlinear restrictions linking expectations at different forecast horizons. The restrictions impose consistency, a property weaker than rationality. We use ex- change rate survey data to measure expectations and then test whether consistency holds. The data show that a current, positive exchange rate shock leads agents to expect a higher long-run future spot rate when iterating forward their short-term expectations than when thinking directly about the long run. In this sense short-horizon expectations may overreact to current exchange rate changes.
Keywords: exchange rates; expectations; foreign exchange market
JEL Codes: F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Current positive exchange rate shock (F31) | Higher long-run future spot rate expectations (E43) |