Heterogeneous Expectations and Tests of Efficiency in the Yen/dollar Forward Exchange Rate Market By

Heterogeneous expectations and tests of efficiency in the yen/dollar forward exchange rate market Abstract This paper examines the efficiency of the forward yen/dollar market using micro survey data. Conventional tests of unbiasedness do not correspond directly to the zero-profit condition. Instead, we use the survey data to calculate potential profits of individual forecasters based on a natural trading rule. We find that although the survey data are not the best predictor of future spot rates in terms of typical mean square forecast error criteria, the survey data can be used to obtain on average positive profits. However, these profits are small and highly variable. Similar results are found when we examine profits generated by a trading rule using regression forecasts. The profits are found to be correlated with risk type variables but not other available information. Acknowledgment: We thank J. Frankel, A. Timmermann, A. Melino, an anonymous referee and seminar participants at the Federal Reserve Board of Governors for their useful comments. Elena Pesavento provided excellent research assistance. We are grateful to the Japan Center for International Finance for their kindly providing us an access to their survey data. Views expressed in the paper are ours.