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Explaining Forward Discount Bias: Is it Anchoring?

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Author Info
David Gruen (Reserve Bank of Australia)
Marianne 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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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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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  5. De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 703-38, August. [Downloadable!] (restricted)
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  6. Charles Engel, 1990. "On the foreign exchange risk premium in a general equilibrium model," Research Working Paper 90-06, Federal Reserve Bank of Kansas City.
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  7. Frankel, Jeffrey A., 1988. "Recent estimates of time-variation in the conditional variance and in the exchange risk premium," Journal of International Money and Finance, Elsevier, vol. 7(1), pages 115-125, March. [Downloadable!] (restricted)
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  8. Baldwin, Richard, 1990. "Re-Interpreting the Failure of Foreign Exchange Market Efficiency Tests: Small Transaction Costs, Big Hysteresis Bands," CEPR Discussion Papers 407, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  9. Bennett T. McCallum, 1994. "A Reconsideration of the Uncovered Interest Parity Relationship," NBER Working Papers 4113, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  13. Lyons, Richard K., 1990. "Whence exchange rate overshooting: Money stock or flow?," Journal of International Economics, Elsevier, vol. 29(3-4), pages 369-384, November. [Downloadable!] (restricted)
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  15. Jeremy Smith & David Gruen, . "A Random Walk around the $A: Expectations, Risk, Interest Rates and Consequences for External Imbalance," RBA Research Discussion Papers rdp8906, Reserve Bank of Australia.
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  17. Paul R. Krugman, 1981. "Consumption Preferences, Asset Demands, and Distribution Effects in International Financial Markets," NBER Working Papers 0651, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  22. Goodhart, Charles, 1988. "The Foreign Exchange Market: A Random Walk with a Dragging Anchor," Economica, London School of Economics and Political Science, vol. 55(220), pages 437-60, November. [Downloadable!] (restricted)
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  25. Northcraft, Gregory B. & Neale, Margaret A., 1987. "Experts, amateurs, and real estate: An anchoring-and-adjustment perspective on property pricing decisions," Organizational Behavior and Human Decision Processes, Elsevier, vol. 39(1), pages 84-97, February. [Downloadable!] (restricted)
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  28. Campbell, John Y. & Clarida, Richard H., 1987. "The dollar and real interest rates," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 27(1), pages 103-139, January. [Downloadable!] (restricted)
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  29. Robert E. Cumby & Maurice Obstfeld, 1985. "International Interest-Rate and Price-Level Linkages Under Flexible Exchalge Rates: A Review of Recent Evidence," NBER Working Papers 0921, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  30. Lewis, Karen K, 1989. "Changing Beliefs and Systematic Rational Forecast Errors with Evidence from Foreign Exchange," American Economic Review, American Economic Association, vol. 79(4), pages 621-36, September. [Downloadable!] (restricted)
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  32. Jeffrey Frankel & Menzie Chinn, 1991. "Exchange Rate Expectations and the Risk Premium: Tests For a Cross- Section of 17 Currencies," NBER Working Papers 3806, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  33. Froot, Kenneth A & Frankel, Jeffrey A, 1989. "Forward Discount Bias: Is It an Exchange Risk Premium?," The Quarterly Journal of Economics, MIT Press, vol. 104(1), pages 139-61, February. [Downloadable!] (restricted)
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  34. Baillie, Richard T. & Bollerslev, Tim, 1990. "A multivariate generalized ARCH approach to modeling risk premia in forward foreign exchange rate markets," Journal of International Money and Finance, Elsevier, vol. 9(3), pages 309-324, September. [Downloadable!] (restricted)
Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Robert J. Shiller, 1998. "Human Behavior and the Efficiency of the Financial System," NBER Working Papers 6375, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  2. Malcolm Edey & John Romalis, 1996. "Issues in Modelling Monetary Policy," RBA Research Discussion Papers rdp9604, Reserve Bank of Australia. [Downloadable!]
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