Exchange Rate Expectations of Chartists and Fundamentalists

The present study compares exchange rate expectations of "chartists" and "fundamentalists". "Chartists" are those financial market participants who base their forecasts and actions on past price movements of their asset (here: a currency). "Fundamentalists", on the other hand, are financial market participants who base their forecasts and actions on economic models.

Various studies give empirical evidence for the presence of chartists and fundamentalists in FX markets. Expectation formation of exchange rate forecasters per se has also been studied from various perspectives in the literature. Our study, however, goes beyond previous research, as it is the first to explicitly connect the two strands of literature: how exactly do professional analysts, who claim to be either chartists or fundamentalists, make their respective exchange rate forecasts?

Our study is divided into three parts. In a first step, we analyze chartists' and fundamentalists' forecast behavior. Models including chartists and fundamentalists often make specific assumptions about these two groups. Our research can help verify these assumptions. In a second step, we model forecast dynamics caused by changes in forecasting strategies and identify the factors motivating a change in strategy. Theoretical models with chartists and fundamentalists suppose that chartists do not systematically perform worse than fundamentalists (as would be expected in efficient markets). Therefore, in a third step, we investigate forecasting performance, i.e. whether chartists’ forecasts may be used as the basis for profitable trading strategies in the same manner as fundamentalists'.

In order to address this question, we combine two data sets. One is a set of micro data consisting of monthly USD/EUR forecasts made by professional analysts starting with the introduction of the Euro. Our second data set comprises information on the self‐assessment of almost 400 of these professional analysts, i.e., on the degree to which they claim to rely on fundamental analysis or chart analysis to make their forecasts. The combination of the two data sets allows us to put analysts' selfassessment and their actual forecasts into context. Our panel comprises more than 30,000 observations over the course of 153 months.

Our results confirm relevant assumptions made in chartist‐fundamentalist models: Chartists follow trends more often than fundamentalists and change the direction of their forecasts more often. However, there are strong influencing factors which alter both groups' forecasts, such as a great deviation from the long‐term fundamental value. Also having experienced a strong trend in the past increases all forecasters' tendency to base forecasts on trends. It should finally be noted that the quality of chartists' forecasts is not inferior to that of fundamentalists' forecasts. On a short‐term horizon, chartists' forecasts even appear to be more accurate than those of fundamentalists.

Dick, Christian and Lukas Menkhoff (2012), Exchange Rate Expectations of Chartists and Fundamentalists, ZEW Discussion Paper No. 12-026, Mannheim.