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Twisting the Dollar? On the Consistency of Short-Run and Long-Run Exchange Rate Expectations

✍ Scribed by Michael Frenkel; Jan-Christoph Rülke; Georg Stadtmann

Publisher
John Wiley and Sons
Year
2011
Tongue
English
Weight
605 KB
Volume
31
Category
Article
ISSN
0277-6693

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✦ Synopsis

ABSTRACT

We examine consistency properties of the exchange rate expectation formation process of short‐run and long‐run forecasts in the dollar/euro and yen/dollar market. Applying nonlinear consistency restrictions we show that in a simple expectation formation structure short‐run forecasts are indeed inconsistent with long‐run predictions. Moreover, we establish a ‘twist’ in the dollar/euro expectation formation process, i.e. market participants expect bandwagon effects in the short run, while they have stabilizing expectations in their long‐run forecasts. Applying a panel probit analysis we find that this twisting behavior is more likely to occur in periods of excess exchange rate volatility. Copyright © 2011 John Wiley & Sons, Ltd.

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