The scapegoat theory of exchange rates: the first tests |
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| Institution: | 1. DIW Berlin and Humboldt University, Mohrenstrasse 58, 10117 Berlin, Germany;2. Centre for Economic Policy Research (CEPR), 77 Bastwick Street, EC1V 3PZ London, UK;3. Department of Finance, BI Norwegian Business School, Nydalsveien 37, 0484 Oslo, Norway;4. Finance Faculty, Cass Business School, City University London, 106 Bunhill Row, London EC1Y 8TZ, UK;5. Bank of Italy, Via Nazionale 91, 00184 Rome, Italy;1. École Polytechnique Fédérale de Lausanne, Switzerland;2. International Monetary Fund, 700 19th Street, N.W., Washington, D.C. 20431, United States;1. Money Market, Swiss National Bank, Boersenstrasse 15, 8022 Zurich, Switzerland;2. Financial Stability – Oversight, Swiss National Bank, Bundesplatz 1, 3003 Bern, Switzerland;1. University of Michigan, USA;2. NBER, USA;1. Federal Reserve Bank of San Francisco, USA;2. University of Oxford, UK;3. University of Chicago, USA;4. Federal Reserve Bank of New York, 33 Liberty Street, 3rd Floor, New York, NY 10045, USA |
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| Abstract: | The scapegoat theory of exchange rates (Bacchetta and van Wincoop, 2004, Bacchetta and van Wincoop, 2013) suggests that market participants may attach excessive weight to individual economic fundamentals, which are picked as “scapegoats” to rationalize observed currency fluctuations at times when exchange rates are driven by unobservable shocks. Using novel survey data that directly measure foreign exchange scapegoats for 12 exchange rates, we find empirical evidence that supports the scapegoat theory. The resulting models explain a large fraction of the variation and directional changes in exchange rates in sample, although their out-of-sample forecasting performance is mixed. |
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| Keywords: | Scapegoat Exchange rates Economic fundamentals Survey data |
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