Expectation formation and rationality analysis: Application on Turkey

This study emprically tests the ?Rationality Hypothesis?, which is the contemporary dominant assumption in economics literature, and the expectation formation mechanisms by using data obtained from CBRT Expectation Survey.Data used in the study consists of 1 month and 12 month ahead USD/TRY exchange rate expectations for the period 2001-2012. Firstly, the rationality of expectations was investigated via unbiasedness, efficiency and restricted cointegration tests. In the following chapter, extrapolative, adaptive and regressive expectation formation mechanisms were tested in order to investigate which of the expectation formation mechanisms forecasters adopt while generating their exchange rate expectations.Results indicated that 1 month ahead exchange rate expectations are unbiased predictors of the realized exchange rates. However, it is found that the economic agents do not always use all available information when forecasting. In addition, rationality hypothesis for 12 month ahead exchange rate expectations is rejected entirely. Moreover, the results show that forecasters take the last forecast error into consideration while forming their expectations and an unexpected movement in exchange rates generates an expectation of movement in the same direction.