Switching between Expectation Processes in the Foreign Exchange Market: a Probabilistic Approach using Survey Data*

Abstract

This paper relaxes a fundamental hypothesis commonly accepted in the expectation formation literature: expectations are, unchangingly, either rational or generated by one of the three simple extrapolative, regressive, or adaptive processes. Using expectations survey data provided by Consensus Forecasts on six European exchange rates against the US dollar, we find that the rational expectations hypothesis is rejected at the aggregate level. By implementing a switching-regression methodology with stochastic choice of regime, we show that the expectation generating process is given at any time by some combination of the three simple processes. An interpretation of this framework in terms of economically rational expectations is suggested. Copyright � 2007 The Authors; Journal compilation � 2007 Blackwell Publishing Ltd.

Modeling the horizon-dependent ex-ante risk premium in the foreign exchange market: Evidence from survey data

“…7 Among others, see MacDonald and Torrance (1990). Prat and Uctum (2007) find similar results for 6 European currencies. Ruelke et al (2010) report the rejection of REH using panel survey data on Yen/Dollar expectations from the Wall Street Journal forecast poll.…”

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

“…5 However,Prat and Uctum's (2007) results do not suffer from this issue since the authors report evidence of dominant probabilities close to one almost at any time.…”

“…However, this conclusion is based upon arbitrary sample separation into sub-periods. To avoid this problem, Prat and Uctum (2007) have proposed a switching-regime probabilistic model based on a mixture of distributions in which changes in regimes are determined endogenously. According to this model, the state of nature may be characterized at any time by one of the three standard extrapolative, regressive, and adaptive processes or by any combination of them.…”

Survol De La Littérature Sur Les Modèles De Taux De Change D’équilibre: Aspects Théoriques Et Discussions Comparatives

“…Cette hypothèse est certes restrictive, car la littérature montre sur données d'enquêtes que les agents forment leurs anticipations en utilisant des processus mixtes extrapolatifs, régressifs et adaptifs. (Prat et Uctum (2007)) Allen (1995 :9) distingue dans le modèle NATREX trois horizons de taux de change : le court terme, le moyen terme sur lequel l'intensité capitalistique et la dette sont données, et le long terme, sur lequel elles varient. À court terme le taux de change réel dépend des fondamentaux (Z), du stock d'actifs nets (a) et de facteurs cycliques et spéculatifs (c).…”