Detecting Scapegoat Effects in the Relationship Between Exchange Rates and Macroeconomic Fundamentals: A New Approach

Abstract

This paper presents a new testing method for the scapegoat model of exchange rates. A number of steps are implemented to determine whether macro-fundamentals are scapegoats for the evolution of exchange rates. Estimation is conducted using a Bayesian Gibbs sampling approach applied to eight countries (five developed and three emerging) versus the USA over the period 2002Q1–2014Q4. The macro-fundamentals that we consider are real GDP growth, the inflation rate, the long-run nominal interest rate, and the current account to GDP ratio. We calculate the posterior probabilities that these macro-fundamentals are scapegoats. For the inflation rate, these probabilities are considerably higher than the imposed prior probabilities of ½ in five out of eight countries (in particular, the Anglo-Saxon economies).

Uncovered interest rate parity redux: Non-uniform effects

“…12 Some empirical studies on the scapegoat theory and exchange rate determination are Bacchetta and Van Wincoop (2013), Cao, at al. (2019), Fratzscher, et al (2015, Markiewicz (2012), and Pozzi and Sadaba (2018).…”

Economic policy uncertainty and exchange rates in emerging markets: Short and long runs evidence

“…Hence, in a rational market, excessive weight is attributed to observable variables (scapegoats) in explaining the exchange rate dynamics. Consequently, possible unobservable determinants are ignored (Bacchetta and Van Winscoop, 2013;Pozzi and Sadaba;.…”

Exchange rate predictability and dynamic Bayesian learning

“…It is interesting how our findings relate to the scapegoat theory for which studies such as Fratzscher et al () and Pozzi and Sadaba () find empirical support. Given our focus on developing and applying a method for out‐of‐sample forecasting, the suggested approach cannot be used as a direct test of the scapegoat theory.…”