Expectation formation in the foreign exchange market: a time-varying heterogeneity approach using survey data

Abstract

we first show that expectations fail the conventional tests of unbiasedness and do not exhibit a learning process towards rationality. Our approach is consistent with the economically rational expectations theory (Feige and Pearce, 1976), which states that information costs and agents' aversion to misestimating future exchange rates determine the optimal amounts of information on which they base their expectations. The time variability of the cost/aversion ratios justifies at the aggregate level a representation of expectations as a linear combination of the traditional extrapolative, adaptive and regressive processes augmented by a forward market component, whose parameters are allowed to change over time. This mixed expectation model with unstable heterogeneity is validated by our Kalman filter estimation results for the two currencies and the two horizons considered. Although the relative importance of the 'fundamentalists' ('chartists') is found to increase (decrease) with the time-horizon, chartist behaviour appears to dominate fundamentalist behaviour for both horizons. Central bank intervention is then effective in stabilizing the foreign exchange markets if it encourages fundamentalist activity.

The role of expectations for currency crisis dynamics—The case of the Turkish lira

“…Expectations are proxied by monthly survey data on forecasts made by professionals taken from Consensus Economics (see https://www.consensuseconomics.com/) which is widely used (see e.g. Marsh and Power, 1996;Reitz et al, 2010;Prat and Uctum, 2015;Kunze, 2020, among many others) given that the names of participants and their competitive forecast adequacy are published (Beckmann and Czudaj, 2018).…”

“…In a very broad sense, the present paper refers to the literature on the expectation formation and the heterogeneity of forecasters on foreign exchange markets based on surveys of professional forecasters (see, e.g., Bacchetta et al, 2009; Beckmann & Czudaj, 2017a, 2017b; Cavusoglu & Neveu, 2015; Kunze, 2020; Marsh & Power, 1996; Prat & Uctum, 2015; Reitz et al, 2010, among many others). More specifically, the following brief discussion summarizes the literature on currency crises and specific explanations for the Turkish currency crisis.…”

“…Expectations are proxied by monthly survey data on forecasts made by professionals taken from Consensus Economics (see https://www.consensuseconomics.com/) which is widely used (see, e.g., Kunze, 2020; Marsh & Power, 1996; Prat & Uctum, 2015; Reitz et al, 2010, among many others) given that the names of participants and their competitive forecast adequacy are published (Beckmann & Czudaj, 2018). Consensus Economics surveys a large number of financial institutions and research institutes for a large number of economies.…”