Using survey expectations data and Markov-switching models, this paper evaluates theudcharacteristics and evolution of investors' forecast errors about the yen/dollar exchangeudrate. Since our model is derived from the uncovered interest rate parity (UIRP)udcondition and our data cover a period of low interest rates, this study is also related toudthe forward premium puzzle and the currency carry trade strategy. We obtain theudfollowing results. First, with the same forecast horizon, exchange rate forecasts areudhomogeneous among different industry types, but within the same industry, exchangeudrate forecasts differ if the forecast time horizon is different. In particular, investors tendudto undervalue the future exchange rate for long term forecast horizons; however, in theudshort run they tend to overvalue the future exchange rate. Second, while forecast errorsudare found to be partly driven by interest rate spreads, evidence against the UIRP isudprovided regardless of the forecasting time horizon; the forward premium puzzleudbecomes more significant in shorter term forecasting errors. Consistent with this finding,udour coefficients on interest rate spreads provide indirect evidence of the yen carry tradeudover only a short term forecast horizon. Furthermore, the carry trade seems to be activeudwhen there is a clear indication that the interest rate will be low in the future.
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