SHORT-RUN AND LONG-RUN EXPECTATIONS OF THE YEN DOLLAR EXCHANGE-RATE

The survey data of the yen/dollar exchange rate, collected twice a mon th for eight years from 1985 to 1993, show the following features. Fir st, the expected exchange rate changes in the short horizon (one month ) are of the bandwagon type while the expected changes in the long hor izon (three to six months) are of the mean-reversion type. That is, fo reign exchange traders infer from recent appreciation or depreciation that the recent change in the exchange rate will continue for a while, but the direction of changes will reverse, eventually. Second, this r esult is robust for the entire sample period, which includes sub-perio ds of sharp yen appreciations and of relative calm, and with respect t o different specifications. Third, the deviation from an equilibrium e xchange rate does not yield a robust estimate in the regression of exp ectation formation. Although the history of the yen/dollar exchange ra te fluctuations in the past two decades shows mean reversion over seve ral years, they are not captured in the six-month expectations in the survey data. (C) 1994 Academic Press, Inc.