Models of Exchange Rate Expectations : Heterogeneous Evidence From Panel Data
Central to an understanding of how foreign exchange markets work is the nature of the expectations formation process. Of particular interest are the potentially stabilising or destabilising nature of these expectations. The purpose of this paper is to determine the nature of the expectations processes governing agents' expectations formation and the degree of heterogeneity of such expectations. We use a unique desegregate expectations data base to model the expectations formation of around 40 leading foreign exchange forecasters/ dealers. Panel estimators are used to increase the power of the tests. Four different expectational structures are examined, namely an extrapolative, an adaptive, a regressive and a mixed model.The expectational series used are extracted from the survey data base of Consensus Forecasts of London, and consist of 3 and 12 month expectations of the US dollar bilateral rates of the German mark, Japanese yen and pound sterling, for the period January 1990 to December 1994. Our testing methods center around two panel estimators, namely a fixed effect model and a random coefficient model. The former is seen as a base-line model in which we capture heterogeneities solely in terms of differing intercepts across individuals, whereas in the latter heterogeneity also exhibits itself in terms of differing coefficients and is summarised with a Swamy test.
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