What's on their Mind: Do Exchange RateForecasters Stick to Theoretical Models ?

Do financial market analysts use structural economic models whenforecasting exchange rates? This is the leading question analysedin this paper. In contrast to other studies we use expectations datainstead of observable variables. Therefore we analyse the implicitstructural models forecasters have in mind when forming theirexchange rate expectations.The economic exchange rate models included in our study arepurchasing power parity, the flexible-price monetary model, thesticky-price monetary model and the Mundell-Fleming model.These models are the theoretical basis for the estimation of latentstructural models using the categorical expectations data of theZEW financial market survey. The expectation variables used toexplain expected exchange rates are short term interest rates, longterm interest rates and business expectations. Our results showthat the flexible-price monetary model is clearly rejected, but thesticky-price monetary model (in case of DM/Pound Sterling andDM/Yen) and the Mundell-Fleming model (in case ofDM/US-Dollar) are both compatible with the estimated parameters.

Schröder, Michael and Robert Dornau (1999), What's on their Mind: Do Exchange RateForecasters Stick to Theoretical Models ? , ZEW Discussion Paper No. 99-08, Mannheim.