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Testing the rationality of exchange rate and interest rate expectations: an empirical study of Australian survey-based expectations

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  • Suk-Joong Kim

Abstract

This paper examines the rationality of the Australian survey-based expectations, 1- and 4-week-ahead $US/$A exchange rate and 2 and 4-week-ahead Australian 90-day bank bill and 10-year bond rates. The actual and expected variables are found to be cointegrated, indicating that the expected future values and the future realizations of the exchange rate and interest rates have long-run equilibrium relationships. OLS estimations with the Newey - West corrections are employed for testing the unbiased expectations hypothesis (UEH) where the frequency of the expectations data is finer than the forecast horizons, and the exponential-GARCH models that take into account the time-varying nature of the forecasterror variance are employed for testing the weak rational expectations hypothesis (WREH). The evidence shows that the WREH could not be rejected in any case, except for the two-week-ahead forecast of the 90-day interest rate, which indicates that all available information is used at the time of forming relevant forecasts. The UEH, however, is decisively rejected in all cases. This indicates that strong rationality, which requires both UEH and WREH, is rejected in all cases. It is concluded that forecasters are weakly rational; however, their forecasts are not unbiased because the data available to them when forming expectations are inadequate.

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  • Suk-Joong Kim, 1997. "Testing the rationality of exchange rate and interest rate expectations: an empirical study of Australian survey-based expectations," Applied Economics, Taylor & Francis Journals, vol. 29(8), pages 1011-1022.
    • Handle: RePEc:taf:applec:v:29:y:1997:i:8:p:1011-1022
    DOI: 10.1080/000368497326408
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    2. Chortareas, Georgios & Jitmaneeroj, Boonlert & Wood, Andrew, 2012. "Forecast rationality and monetary policy frameworks: Evidence from UK interest rate forecasts," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 22(1), pages 209-231.
    3. Prat, Georges & Uctum, Remzi, 2021. "Term structure of interest rates: Modelling the risk premium using a two horizons framework," Journal of Economic Behavior & Organization, Elsevier, vol. 182(C), pages 421-436.
    4. Puah, Chin-Hong & Wong, Shirly Siew-Ling & Habibullah, Muzafar Shah, 2012. "Rationality of business operational forecasts: evidence from Malaysian distributive trade sector," MPRA Paper 37599, University Library of Munich, Germany.
    5. Ron Jongen & Willem F.C. Verschoor & Christian C.P. Wolff, 2008. "Foreign Exchange Rate Expectations: Survey And Synthesis," Journal of Economic Surveys, Wiley Blackwell, vol. 22(1), pages 140-165, February.
    6. Anastasiou, Dimitrios, 2020. "Senior bank loan officers' expectations for loan demand: Evidence from the Euro-area," MPRA Paper 98903, University Library of Munich, Germany.
    7. Chin-Hong Puah & Shirly Siew-Ling Wong & Venus Khim-Sen Liew, 2013. "Testing rational expectations hypothesis in the manufacturing sector in Malaysia," Journal of Business Economics and Management, Taylor & Francis Journals, vol. 14(2), pages 303-316, April.
    8. Hogan, Warren P. & Batten, Jonathan A., 2005. "Informed and uninformed trading on the Australian dollar," International Review of Financial Analysis, Elsevier, vol. 14(1), pages 61-75.

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