Politická ekonomie 2024, 72(5):752-779 | DOI: 10.18267/j.polek.1426

Evaluation of Accuracy of Exchange Rate Expectation Models for Understanding Observed Expectations

Jáchym Novotný ORCID...
Jáchym Novotný: Prague University of Economics and Business, Faculty of Economics, Prague, Czech Republic

Exchange rate expectations are a crucial element in the main monetary models. Therefore, this paper analyses the mechanism behind their formation. To achieve this, we analyse traditional expectation models using data from the Survey of Professional Forecasters (SPF) for the CZK/EUR currency pair. The data used cover one-year expectations in the period from January 2001 to December 2022, which are provided monthly by the Czech National Bank (CNB). The paper demonstrates the poor performance of the perfect expectation model. Furthermore, it demonstrates that traditional models, such as static, extrapolative, regressive and adaptive expectations, exhibit some explanatory power but lack robustness. The only traditional model that exhibits robustness is the model based on the UIP puzzle, which also outperforms all other traditional models when evaluated using error metrics. Based on these observations, the paper introduces a non-traditional model in which agents simply shift the current spot value by a constant into the future. This model displays robustness and outperforms the others.

Keywords: Financial markets; exchange rate; CZK/EUR; expectations
JEL classification: E47, F31, G17

Received: September 3, 2023; Revised: November 12, 2023; Accepted: December 1, 2023; Published: October 10, 2024  Show citation

ACS AIP APA ASA Harvard Chicago Chicago Notes IEEE ISO690 MLA NLM Turabian Vancouver
Novotný, J. (2024). Evaluation of Accuracy of Exchange Rate Expectation Models for Understanding Observed Expectations. Politická ekonomie, 72(5), 752-779. doi: 10.18267/j.polek.1426
Download citation
  • BibTeX (.bib)
  • Bookends (.ris)
  • EasyBib (.ris)
  • EndNote (.enw)
  • EndNote 8 (.xml)
  • ISI WoS (.isi)
  • Medlars (.medlars)
  • Mendeley (.ris)
  • MODS (.xml)
  • Papers (.ris)
  • RefWorks (.txt)
  • RefManager (.ris)
  • RIS (.ris)
  • MS Word (.xml)
  • Zotero (.ris)
    • Open full article

    References

    1. Aliyev I., Bobková B., Štork Z. (2014). Extended DSGE Model of the Czech Economy. Ministry of Finance of the Czech Republic - Working Paper No. 1/2014.
    2. Backus, D., Gavazzoni, F., Telmer, C., et al. (2010). Monetary Policy and the Uncovered Interest Rate Parity Puzzle. NBER Working Paper 16218. https://doi.org/10.3386/w16218 Go to original source...
    3. Baghestani, H., Danila, L. (2014). Interest Rate and Exchange Rate Forecasting in the Czech Republic: Do Analysts Know Better than a Random Walk? Finance a úvěr - Czech Journal of Economics and Finance, 64(4), 285-295.
    4. Bénassy-Queré, A., Larribeau S., MacDonald R. (2003). Models of exchange rate expectations: how much heterogeneity? Journal of International Financial Markets, Institutions and Money, 13(2), 113-136. https://doi.org/10.1016/S1042-4431(02)00040-9 Go to original source...
    5. Brázdik, F., Hlédik, T., Humplová, Z., et al. (2020). The g3+ Model: An Upgrade of the Czech National Bank's Core Forecasting Framework. Czech National Bank Working Papers Series 7/2020.
    6. Cagan, P. (1956). The monetary dynamics of hyperinflation. In: Friedman, M. Studies in the Quantity Theory of Money. Chicago: University of Chicago Press. ISBN 978-0226264066.
    7. Candian, G., De Leo (2023). Imperfect Exchange Rate Expectations. The Review of Economics and Statistics, 1-46. https://doi.org/10.1162/rest_a_01343 Go to original source...
    8. Chen, L.-L., Choi, S., Devereux, J. (2015). Explaining Price Level Differences: New Evidence on the Balassa-Samuelson Effect. Southern Economic Journal, 82(1), 81-99. https://doi.org/10.4284/0038-4038-2012.235 Go to original source...
    9. CNB (2023a). Financial market inflation expectations. [Retrieved 03-02-2023] Available at: https://www.cnb.cz/en/financial-markets/inflation-expectations-ft/
    10. CNB (2023b). FX rates of other currencies. [Retrieved 03-02-2023] Available at: https://www.cnb.cz/en/financial-markets/foreign-exchange-market/fx-rates-of-other-currencies/fx-rates-of-other-currencies/
    11. CNB (2023c). Fixing of Interest Rates on Interbank Deposits - PRIBOR. [Retrieved 03-02-2023] Available at: https://www.cnb.cz/en/financial-markets/money-market/pribor/fixing-of-interest-rates-on-interbank-deposits-pribor/
    12. Dornbusch, R. (1976). Expectations and Exchange Rate Dynamics. Journal of Political Economy, 84(6), 1161-1176. https://doi.org/10.1086/260506 Go to original source...
    13. Dreger, C., Stadtmann, G. (2008). What drives heterogeneity in foreign exchange rate expectations: Insights from a new survey. International Journal of Finance & Economics, 13(4), 360-367. https://doi.org/10.1002/ijfe.359 Go to original source...
    14. ECB (2023). EURIBOR rates by year. [Retrieved 01-02-2023] Available at: https://www.euribor-rates.eu/en/euribor-rates-by-year/
    15. Fama, E. F. (1984). Forward and spot exchange rates. Journal of Monetary Economics, 14(3), 319-338. Go to original source...
    16. Fisher, I. (1930). The Theory of Interest. New York: Macmillan and Co.
    17. Friedman, M. (1968). The Role of Monetary Policy. The American Economic Review, 58(1), 1-17.
    18. Froot, K. (1990). Exchange Rate Forecasting Techniques, Survey Data, and Implications for the Foreign Exchange Market. IMF Working Paper 90/43. Go to original source...
    19. Froot, K. A., Thaler, R. H. (1990). Anomalies: Foreign Exchange. Journal of Economic Perspectives, 4(3), 179-192. https://doi.org/10.1257/jep.4.3.179 Go to original source...
    20. Hodrick, R. J., Prescott, E. C. (1997). Postwar U.S. Business Cycles: An Empirical Investigation. Journal of Money, Credit and Banking, 29(1), 1-16, 11(7/8). https://doi.org/10.2307/2953682 Go to original source...
    21. Kremens, L., Martin, I. W. R., Varela, L. (2023). Long-Horizon Exchange Rate Expectations. Paul Woolley Centre Working Paper No. 96. Go to original source...
    22. Kladívko, K., Österholm, P. (2023). Analysts versus the random walk in financial forecasting: evidence from the Czech National Bank's Financial Market Inflation Expectations survey. Applied Economics, 56(17), 1 -12. https://doi.org/10.1080/00036846.2023.2178633 Go to original source...
    23. Lizondo, J. S. (1983). The efficiency of the Mexican peso market. Journal of International Economics, 14, 69-84. Go to original source...
    24. Mandel, M., Vejmělek, J. (2021a). Testing the Properties of Financial Analysts' Predictions of Future Spot Exchange Rates (Example of CZK/EUR). Finance a úvěr - Czech Journal of Economics and Finance, 71(1), 33-51. https://doi.org/10.32065/CJEF.2021.01.02 Go to original source...
    25. Mandel, M., Vejmělek, J. (2021b). Analýza vzájemných vztahů v nekryté úrokové paritě (příklad měnového páru CZK/EUR). Politická ekonomie, 69(3), 340-359. https://doi.org/10.18267/j.polek.1322 Go to original source...
    26. Macdonald, R., Taylor, M. P. (1992). Exchange Rate Economics: A Survey. IMF Staff Papers, 39(1), 1-57. Go to original source...
    27. Metzler, L. (1941). The Nature and Stability of Inventory Cycles. Review of Economics and Statistics, 23(3), 113-129. https://doi.org/10.2307/1927555 Go to original source...
    28. Mundell, R. (1963). Capital Mobility and Stabilization Policy under Fixed and Fixed and Flexible Exchange Rates. Canadian Journal of Economics and Political Science, 29, 475-485. https://doi.org/10.2307/139336 Go to original source...
    29. Muth, F. J. (1961). Rational Expectations and the Theory of Price Movements. Econometrica, 29(3), 315-335. https://doi.org/10.2307/1909635 Go to original source...
    30. Takagi, S. (1991). Exchange Rate Expectations: A Survey of Survey Studies. IMF Staff Papers (International Monetary Fund), 38(1), 156-183. https://doi.org/10.2307/3867039 Go to original source...
    31. Svendsen, I. (1993). Empirical Tests of the Formation of Expectations: A Survey of Methods and Results. Oslo: Statistics Norway. ISBN 82-537-3948-6.

    This is an open access article distributed under the terms of the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International License (CC BY NC ND 4.0), which permits non-comercial use, distribution, and reproduction in any medium, provided the original publication is properly cited. No use, distribution or reproduction is permitted which does not comply with these terms.


    Return to the content