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Article
| Journal of International Money and Finance
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December 1989
On the Consistency of Short-Run and Long-Run Exchange Rate Expectations
by
K. A. Froot and T. Ito
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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;
Curency areas;
rational expectations;
Asset Pricing;