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Measuring the Financial Markets’ Perception of EMU Enlargement: The Role of Ambiguity Aversion

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Abstract

Market views on EMU enlargement are measured by a new indicator based on the short-term dynamics of forward spreads. Conceptually, this indicator stems from the notion of ambiguity-averse agents in the sense of Knight. Specifically, we attempt to operationalize the incomplete preferences framework, which may allow for multiple equilibria supported by one set of fundamentals. This equilibrium indeterminacy may offer a way to reconcile short-term fluctuations of market prices with a relatively stable underlying economic environment and expectations. The method was applied to data from Central European countries, including the Czech Republic, Hungary, Poland, and Slovakia. Comparing our results with financial market opinion surveys, the results of the proposed method seems to be in accordance with market expectations.

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Article provided by Charles University Prague, Faculty of Social Sciences in its journal Finance a uver - Czech Journal of Economics and Finance.

Volume (Year): 58 (2008)
Issue (Month): 05-06 (August)
Pages: 210-230

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Handle: RePEc:fau:fauart:v:58:y:2008:i:5-6:p:210-230

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Keywords: ambiguity aversion; EMU calculators; EMU enlargement; EMU Poll; forwards; uncertainty;

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  1. Favero, Carlo A., 1999. "Financial markets' assessments of EMU : A comment," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 51(1), pages 271-280, December.
  2. Favero, Carlo A & Giavazzi, Francesco & Spaventa, Luigi, 1996. "High Yields: The Spread on German Interest Rates," CEPR Discussion Papers 1330, C.E.P.R. Discussion Papers.
  3. David Schmeidler, 1989. "Subjective Probability and Expected Utility without Additivity," Levine's Working Paper Archive 7662, David K. Levine.
  4. Mukerji, S. & Tallon, J.-M., 2000. "Ambiguity Aversion and the Absence of Indexed Debt," Economics Series Working Papers 9928, University of Oxford, Department of Economics.
  5. Angeloni, I. & Violi, R., 1997. "Long-Term Interest Rate Convergence in Europe and the Probability of EMU," Papers 322, Banca Italia - Servizio di Studi.
  6. Rigotti, Luca & Shannon, Chris, 2001. "Uncertainty and Risk in Financial Markets," Department of Economics, Working Paper Series qt7pp7113z, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  7. Jean-Marc Tallon & Sujoy Mukerji, 2004. "Ambiguity aversion and the absence of wage indexation," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00174562, HAL.
  8. Favero, Carlo A & Giavazzi, Francesco & Iacone, Fabrizio & Tabellini, Guido, 1997. "Extracting Information from Asset Prices: The Methodology of EMU Calculators," CEPR Discussion Papers 1676, C.E.P.R. Discussion Papers.
  9. David Backus & Bryan Routledge & Stanley Zin, 2004. "Exotic Preferences for Macroeconomists," NBER Working Papers 10597, National Bureau of Economic Research, Inc.
  10. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April.
  11. Kocenda, Evzen & Valachy, Juraj, 2006. "Exchange rate volatility and regime change: A Visegrad comparison," Journal of Comparative Economics, Elsevier, vol. 34(4), pages 727-753, December.
  12. Anderson, Heather M, 1997. "Transaction Costs and Non-linear Adjustment towards Equilibrium in the US Treasury Bill Market," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 59(4), pages 465-84, November.
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