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Exchange Rate Markets And Conservative Inferential Expectations

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  • Gordon Menzies

    ()

  • Daniel Zizzo

    ()

Abstract

We present a macroeconomic market experiment on the financial determination of exchange rates, and consider whether the assumption that belief formation be treated as a classical hypothesis test, which we label inferential expectations, can explain the effect of uncertainty on exchange rates. In a non-stochastic environment, exchange rates closely follow standard predictions. In our stochastic environment, inferential expectations with a low test size alpha (conservative inferential expectations) predict exchange rates better than rational expectations in ten sessions out of twelve. Belief conservatism appears magnified rather than diminished at the market level, and the degree of belief conservatism seems connected to the failure of uncovered interest rate parity regressions.

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Bibliographic Info

Paper provided by Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University in its series CAMA Working Papers with number 2007-02.

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Length: 66 pages
Date of creation: Dec 2006
Date of revision:
Handle: RePEc:een:camaaa:2007-02

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References

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  1. Gordon Menzies & Daniel John Zizzo, 2005. "Inferential Expectations," Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney 159, Quantitative Finance Research Centre, University of Technology, Sydney.
  2. Philippe Bacchetta & Eric van Wincoop, 2005. "Incomplete Information Processing: A Solution to the Forward Discount Puzzle," Working Papers, Swiss National Bank, Study Center Gerzensee 05.03, Swiss National Bank, Study Center Gerzensee.
  3. N. Gregory Mankiw & Ricardo Reis, 2001. "Sticky Information Versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," NBER Working Papers 8290, National Bureau of Economic Research, Inc.
  4. Lewis, Karen K, 1989. "Changing Beliefs and Systematic Rational Forecast Errors with Evidence from Foreign Exchange," American Economic Review, American Economic Association, American Economic Association, vol. 79(4), pages 621-36, September.
  5. Olivier Jean Blanchard & Stanley Fischer, 1989. "Lectures on Macroeconomics," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262022834, December.
  6. Chinn, Menzie D. & Meese, Richard A., 1995. "Banking on currency forecasts: How predictable is change in money?," Journal of International Economics, Elsevier, Elsevier, vol. 38(1-2), pages 161-178, February.
  7. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  8. Christopher D Carroll, 2002. "Macroeconomic Expectations of Households and Professional Forecasters," Economics Working Paper Archive, The Johns Hopkins University,Department of Economics 477, The Johns Hopkins University,Department of Economics.
  9. Robin Cubitt & Chris Starmer & Robert Sugden, 2001. "Discovered preferences and the experimental evidence of violations of expected utility theory," Journal of Economic Methodology, Taylor & Francis Journals, Taylor & Francis Journals, vol. 8(3), pages 385-414.
  10. Eric Fisher, 2004. "Exploring Elements of Exchange Rate Theory in a Controlled Enivronment," Levine's Bibliography 122247000000000199, UCLA Department of Economics.
  11. Noussair, Charles N. & Plott, Charles R. & Riezman, Raymond. G., 1995. "The Principles of Exchange Rate Determination in an International Finance Experiment," Working Papers, California Institute of Technology, Division of the Humanities and Social Sciences 908, California Institute of Technology, Division of the Humanities and Social Sciences.
  12. Swenson, Charles W., 1997. "Rational expectations and tax policy: Experimental market evidence," Journal of Economic Behavior & Organization, Elsevier, Elsevier, vol. 32(3), pages 433-455, March.
  13. Goldberg, Michael D & Frydman, Roman, 1996. "Imperfect Knowledge and Behaviour in the Foreign Exchange Market," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 106(437), pages 869-93, July.
  14. Evans, Dorla A, 1997. "The Role of Markets in Reducing Expected Utility Violations," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 105(3), pages 622-36, June.
  15. Mankiw, N Gregory & Miron, Jeffrey A, 1986. "The Changing Behavior of the Term Structure of Interest Rates," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 101(2), pages 211-28, May.
  16. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, Elsevier, vol. 4(2), pages 103-124, April.
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Citations

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Cited by:
  1. Timo Henckel & Gordon Menzies & Nicholas Prokhovnik & Daniel Zizzo, 2010. "Barro-Gordon Revisited: Reputational Equilibria with Inferential Expectations," University of East Anglia Applied and Financial Economics Working Paper Series, School of Economics, University of East Anglia, Norwich, UK. 018, School of Economics, University of East Anglia, Norwich, UK..
  2. Timo Henckel & Gordon D. Menzies & Daniel J. Zizzo, 2010. "Threshold Pricing in a Noisy World," CAMA Working Papers, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University 2010-01, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  3. Gordon Menzies & Daniel Zizzo, 2008. "News And Expectations In Financial Markets: An Experimental Study," CAMA Working Papers, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University 2008-34, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  4. Bruce Lyons & Gordon Menzies & Daniel Zizzo, 2012. "Conflicting evidence and decisions by agency professionals: an experimental test in the context of merger regulation," Theory and Decision, Springer, Springer, vol. 73(3), pages 465-499, September.
  5. Bruce Lyons & Gordon Douglas Menzies & Daniel John Zizzo, 2009. "Professional interpretation of the standard of proof: An experimental test on merger regulation," Working Paper series, University of East Anglia, Centre for Behavioural and Experimental Social Science (CBESS), School of Economics, University of East Anglia, Norwich, UK. 09-16, School of Economics, University of East Anglia, Norwich, UK..

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