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Twisting the Dollar? On the Consistency of Short-Run and Long-Run Exchange Rate Expectations


Jan-Christoph Rülke, Department of Economics, WHU–Otto Beisheim School of Management, Vallendar, Germany. E-mail:


We examine consistency properties of the exchange rate expectation formation process of short-run and long-run forecasts in the dollar/euro and yen/dollar market. Applying nonlinear consistency restrictions we show that in a simple expectation formation structure short-run forecasts are indeed inconsistent with long-run predictions. Moreover, we establish a ‘twist’ in the dollar/euro expectation formation process, i.e. market participants expect bandwagon effects in the short run, while they have stabilizing expectations in their long-run forecasts. Applying a panel probit analysis we find that this twisting behavior is more likely to occur in periods of excess exchange rate volatility. Copyright © 2011 John Wiley & Sons, Ltd.