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Explaining Forward Discount Bias: Is it Anchoring?

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  • David W.R. Gruen

    (Reserve Bank of Australia)

  • Marianne C. Gizycki

    (Reserve Bank of Australia)

Abstract

Anchoring is a well-documented behaviour pattern. It occurs when agents form their expectations of an objective variable by only partially adjusting from some given starting value. We present a model of the foreign exchange market in which there are two types of traders: those who are fully rational and those whose expectations are anchored to the forward exchange rate. Under plausible conditions, a significant proportion of the anchored traders survive in the market in the long-run. The model explains both forward discount bias in the direction consistently observed in foreign exchange markets and the results of surveys of market participants’ exchange rate expectations.

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Bibliographic Info

Paper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp9307.

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Date of creation: Jun 1993
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Handle: RePEc:rba:rbardp:rdp9307

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  1. Kenneth A. Froot and Jeffrey A. Frankel., 1988. "Forward Discount Bias: Is It an Exchange Risk Premium?," Economics Working Papers 8874, University of California at Berkeley.
  2. Jeffrey A. Frankel & Charles Engel, 1985. "Do Asset-Demand Functions Optimize over the Mean and Variance of Real Returns? A Six-Currency Test," NBER Working Papers 1051, National Bureau of Economic Research, Inc.
  3. De Long, J. Bradford & Shleifer, Andrei & Summers, Lawrence H. & Waldmann, Robert J., 1991. "The Survival of Noise Traders in Financial Markets," Scholarly Articles 3725470, Harvard University Department of Economics.
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Cited by:
  1. Baryla Jr., Edward A. & Borghesi, Richard A. & Dare, William H. & Dennis, Steven A., 2007. "Learning, price formation and the early season bias in the NBA," Finance Research Letters, Elsevier, vol. 4(3), pages 155-164, September.
  2. Powell, A.A., 1995. "From Dornbush to Murphy: Stylized Monetary Dynamics of a Contemporary Macroeconometric Model," Monash Econometrics and Business Statistics Working Papers 13/95, Monash University, Department of Econometrics and Business Statistics.
  3. Malcolm Edey & John Romalis, 1996. "Issues in Modelling Monetary Policy," RBA Research Discussion Papers rdp9604, Reserve Bank of Australia.
  4. Robert J. Shiller, 1998. "Human Behavior and the Efficiency of the Financial System," NBER Working Papers 6375, National Bureau of Economic Research, Inc.

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