The Scapegoat Theory of Exchange Rates: The First Tests
68 Pages Posted: 28 Feb 2015
Date Written: October 23, 2014
The scapegoat theory of exchange rates (Bacchetta and van Wincoop 2004, 2013) suggests that market participants may attach excessive weight to individual economic fundamentals, which are picked as scapegoats to rationalize observed currency fluctuations at times when exchange rates are driven by unobservable shocks. Using novel survey data that directly measure foreign exchange scapegoats for 12 exchange rates, we find empirical evidence that supports the scapegoat theory. The resulting models explain a large fraction of the variation and directional changes in exchange rates in sample, although their out-of-sample forecasting performance is mixed.
Keywords: scapegoat, exchange rates, economic fundamentals, survey data
JEL Classification: F31, G10
Suggested Citation: Suggested Citation