Publications
Publications
- December 1989
- Journal of International Money and Finance
On the Consistency of Short-Run and Long-Run Exchange Rate Expectations
By: K. A. Froot and T. Ito
Abstract
This paper examines whether short-term exchange rate expectations 'overreact' 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 exchange rate survey data to measure expectations and then test whether consistency holds. The data show that a current, positive exchange rate shock leads investors 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
Currencies; Exchange Rates; International Macroeconomics; Monetary Policy; Currency Controls; Fixed Exchange Rates; Floating Exchange Rates; Currency Bands; Currency Zones; Currency Areas; Rational Expectations; Asset Pricing
Citation
Froot, K. A., and T. Ito. "On the Consistency of Short-Run and Long-Run Exchange Rate Expectations." Journal of International Money and Finance 8, no. 4 (December 1989): 487–510. (Revised from NBER Working Paper No. 2577, May 1988.)