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Explaining Forecasting Bias: the Case of Real Exchange Rate Variance

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  • Dudley, L.

Abstract

Recent Tests of the Rational Expectations Hypothesis (R.E.H.) Based on the Assumption That Agents Are Risk-Neutral Have Yielded Conflicting Results When Applied to Foreign Exchange Markets. Here a Two-Stage Procedure Which Does Not Assume Risk Neutrality Is Derived From a Model of a Utility Maximizing Importer Who Incurs on Adjustment Cost If He Changes His Import Order. Although a Short-Run Test (Based on Aggregate Imports) Leads to Rejection of the R.E.H. in the Majority of Cases. a Longer-Run Test (Based on Machinery Imports) Is More Favorable to the Null Hypothesis. the Observed Short-Run Tendency to in Effect Ignore Low Levels of Real Exchange-Rate Variation Is Found to Be More Likely When Bilateral Rates Have Remained Relatively Stable, When the Importing Economy Is Relatively Closed, Or When Governments Have Announced Policies of Intervention to Stabilize Bilateral Rates.

Suggested Citation

  • Dudley, L., 1986. "Explaining Forecasting Bias: the Case of Real Exchange Rate Variance," Cahiers de recherche 8659, Universite de Montreal, Departement de sciences economiques.
    • Handle: RePEc:mtl:montde:8659
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    Cited by:

    1. Robert Kremer & Sherrill Shaffer, 2007. "Improving the accuracy of forward exchange rate forecasts by correcting for prior bias," Applied Financial Economics, Taylor & Francis Journals, vol. 17(18), pages 1469-1478.

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