Rethinking What Survey Data has to Say about the Role of Risk and Irrationality in Currency Markets

Josh Stillwagon (jstillwagon@babson.edu)

No 1314, Working Papers from Trinity College, Department of Economics

Abstract: A number of studies have used survey data on traders' exchange rate forecasts to examine the role of risk and non-REH forecasting in accounting for excess returns in currency markets. This work re-examines those results using an alternative estimation technique, the Cointegrated VAR, which allows for better examination of non-stationarity in a multivariate framework. The results demonstrate the importance of focusing on the persistence of deviations from any found relationships. Consistent with some later studies, clear evidence of a time-varying risk premium is found, and REH is rejected for all three exchange rate samples examined (BP/USD, DM/USD, and JY/USD). The results strongly draw into question though the interpretation that this represents obvious irrationality. The relationship between the forecast error and interest rate differential is found to be non-stationary at very high significance levels, implying that the correlations are spurious and unstable over time, and individuals are not, in fact, mis-forecasting in a fixed manner relative to interest rates.

Keywords: Excess returns puzzle; survey data; risk premium; non-stationarity; irrationality (search for similar items in EconPapers)
JEL-codes: F31 G02 G14 G15 (search for similar items in EconPapers)
Pages: 14 pages
Date: 2013-12
New Economics Papers: this item is included in nep-for and nep-mon
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http://www3.trincoll.edu/repec/WorkingPapers2013/WP13-14.pdf First version, 2013 (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:tri:wpaper:1314

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