Dynamic Expectation Formation in the Foreign Exchange Market

41 Pages Posted: 12 May 2011 Last revised: 1 Feb 2016

See all articles by Saskia ter Ellen

Saskia ter Ellen

Norges Bank

Willem F. C. Verschoor

Vrije Universiteit Amsterdam, School of Business and Economics; Tinbergen Institute - Tinbergen Institute Amsterdam (TIA)

Remco C. J. Zwinkels

Vrije Universiteit Amsterdam; Tinbergen Institute - Tinbergen Institute Amsterdam (TIA)

Date Written: March 31, 2011

Abstract

This paper investigates the time-varying nature of expectation formation rules for institutional investors in the foreign exchange market. Using a unique dataset of survey expectations for four exchange rates, we first distinguish three different general rules. We find a momentum rule, a fundamental rule, and a rule that takes advantage of interest differentials between countries. Apart from heterogeneity in expectation formation rules, we show that the rules are time-varying conditional on a number of different factors, such as the sign of the most recent return, the forecast horizon, the distance to the PPP rate, and the extent to which the rule produces forecast errors vis-à-vis the market exchange rate. Although we find dynamics in expectation formation for all four exchange rates, the results for the currencies against the Japanese yen deviate from the others.

Keywords: foreign exchange expectations, investor sentiment, market anomalies, survey data

JEL Classification: G12, G15

Suggested Citation

ter Ellen, Saskia and Verschoor, Willem F. C. and Zwinkels, Remco C.J., Dynamic Expectation Formation in the Foreign Exchange Market (March 31, 2011). Journal of International Money and Finance, Vol. 37, 2013. Available at SSRN: https://ssrn.com/abstract=1837568 or http://dx.doi.org/10.2139/ssrn.1837568

Saskia Ter Ellen (Contact Author)

Norges Bank ( email )

P.O. Box 1179
Oslo, N-0107
Norway

Willem F. C. Verschoor

Vrije Universiteit Amsterdam, School of Business and Economics ( email )

De Boelelaan 1105
Amsterdam, 1081 HV
Netherlands

Tinbergen Institute - Tinbergen Institute Amsterdam (TIA) ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

Remco C.J. Zwinkels

Vrije Universiteit Amsterdam ( email )

De Boelelaan 1105
Amsterdam, NL-1081HV
Netherlands
+31 20 59 85220 (Phone)

HOME PAGE: http://research.vu.nl/en/persons/remco-zwinkels

Tinbergen Institute - Tinbergen Institute Amsterdam (TIA) ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

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