Fundamental determinants of exchange rate expectations

Joscha Beckmann and Robert Czudaj

MPRA Paper from University Library of Munich, Germany

Abstract: This paper provides a new perspective on the expectations building mechanism in foreign exchange markets. We analyze the role of expectations regarding macroeconomic fundamentals for expected exchange rate changes. In doing so, we assess real-time survey data for 29 economies from 2002 to 2023 and consider expectations regarding GDP growth, inflation, interest rates, and current accounts. Our empirical findings show that fundamentals expectations are more important over longer horizons compared to shorter horizons. We find that an expected increase in GDP growth relative to the US leads to an expected appreciation of the domestic currency while higher relative inflation expectations lead to an expected depreciation, a finding consistent with purchasing power parity. Our results also indicate that the expectation building process differs systematically across pessimistic and optimistic forecasts with the former paying more attention to fundamentals expectations. Finally, we also observe that fundamentals expectations have some explanatory power for forecast errors, especially for longer horizons.

Keywords: Exchange rates; Expectations; Forecast errors; Fundamentals; Survey data (search for similar items in EconPapers)
JEL-codes: F31 F37 G17 (search for similar items in EconPapers)
Date: 2024-04
New Economics Papers: this item is included in nep-mon and nep-opm
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https://mpra.ub.uni-muenchen.de/120648/1/MPRA_paper_120648.pdf original version (application/pdf)

Related works:
Working Paper: Fundamental determinants of exchange rate expectations (2022)
Working Paper: Fundamental determinants of exchange rate expectations (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:120648

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