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

Josh Stillwagon ()

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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