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Rate of return parity and currency crises in experimental asset markets

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  • Childs, Jason
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    Abstract

    This paper explores the impact of exchange rate uncertainty on the predictive power of rate of return parity in a laboratory environment, extending the work of Fisher and Kelly [Fisher, E.O., Kelly, F.S., 2000. Experimental foreign exchange markets. Pacific Economic Review 5, 365-388] and Childs and Mestelman [Childs, J., Mestelman, S., 2006. Rate of return parity in experimental asset markets. Review of International Economics 14, 331-347]. While these works use unchanging exchange rates, this paper allows for a change in the exchange rate between laboratory currencies. The data indicate rate of return parity is weakened by the potential for a currency crisis. The results also indicate that currency crises can be caused by self-fulfilling prophecies and that the level of reserves with which a fixed exchange rate is defended impacts the timing of a crisis but does not significantly change the likelihood of a currency crisis.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of International Financial Markets, Institutions and Money.

    Volume (Year): 19 (2009)
    Issue (Month): 1 (February)
    Pages: 157-170

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    Handle: RePEc:eee:intfin:v:19:y:2009:i:1:p:157-170

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    Web page: http://www.elsevier.com/locate/intfin

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    Keywords: Currency crisis Rate of return parity Experiment;

    References

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    1. Maurice Obstfeld, 1999. "Open-Economy Macroeconomics, Developments in Theory and Policy," NBER Working Papers 6319, National Bureau of Economic Research, Inc.
    2. Jason Childs & Stuart Mestelman, 2004. "Rate of Return Parity in Experimental Asset Markets," McMaster Experimental Economics Laboratory Publications 2004-07, McMaster University.
    3. Frank Heinemann, 2002. "Exchange-rate Attack as a Coordination Game: Theory and Experimental Evidence," Oxford Review of Economic Policy, Oxford University Press, vol. 18(4), pages 462-478.
    4. Smith, Vernon L & Suchanek, Gerry L & Williams, Arlington W, 1988. "Bubbles, Crashes, and Endogenous Expectations in Experimental Spot Asset Markets," Econometrica, Econometric Society, vol. 56(5), pages 1119-51, September.
    5. Mendoza, Ronald U., 2004. "International reserve-holding in the developing world: self insurance in a crisis-prone era?," Emerging Markets Review, Elsevier, vol. 5(1), pages 61-82, March.
    6. Maurice Obstfeld, 1984. "Rational and Self-Fulfilling Balance-of-Payments Crises," NBER Working Papers 1486, National Bureau of Economic Research, Inc.
    7. Alain P. Chaboud & Jonathan H. Wright, 2003. "Uncovered interest parity: it works, but not for long," International Finance Discussion Papers 752, Board of Governors of the Federal Reserve System (U.S.).
    8. Suheyla Ozyildirim & Bulent Yaman, 2005. "Optimal versus adequate level of international reserves: evidence for Turkey," Applied Economics, Taylor & Francis Journals, vol. 37(13), pages 1557-1569.
    9. Menzie D. Chinn & Guy Meredith, 2004. "Monetary Policy and Long-Horizon Uncovered Interest Parity," IMF Staff Papers, Palgrave Macmillan, vol. 51(3), pages 409-430, November.
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