Understanding How Exchange Rates are Perceived and How That Perception Affects Exchange Rate Forecasts

People perceive the same level of nominal exchange rate as overvalued at one point in time and undervalued at a different point in time. To capture the perception of the exchange rate at specific times, we suggest constructing the perceived exchange rate by counting the newspaper articles with phrases ’appreciated currency’ or ’depreciated currency.’ A shift in the perceived exchange rate (PER) index alters the dynamic response of exchange rates in time series. The PER index is a valid threshold variable in forecasting future exchange rates. The forecast model with the PER index as a threshold variable (PER TAR) outperforms models utilizing the lagged exchange rates as a threshold variable. We also show that the forecast precision of the PER TAR model is as good as the survey forecasts by market participants.