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Exchange Rate Markets And Conservative Inferential Expectations

  • Gordon Menzies

    ()

  • Daniel Zizzo

    ()

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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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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  1. Evans, Dorla A, 1997. "The Role of Markets in Reducing Expected Utility Violations," Journal of Political Economy, University of Chicago Press, vol. 105(3), pages 622-36, June.
  2. N. Gregory Mankiw & Ricardo Reis, 2001. "Sticky Information Versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," Harvard Institute of Economic Research Working Papers 1922, Harvard - Institute of Economic Research.
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  4. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  5. Gordon D. Menzies & Daniel John Zizzo, 2005. "Inferential Expectations," CAMA Working Papers 2005-12, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  6. Eric Fisher, 2004. "Exploring Elements of Exchange Rate Theory in a Controlled Enivronment," Levine's Bibliography 122247000000000199, UCLA Department of Economics.
  7. 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.
  8. 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, vol. 8(3), pages 385-414.
  9. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
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  11. Mankiw, N Gregory & Miron, Jeffrey A, 1986. "The Changing Behavior of the Term Structure of Interest Rates," The Quarterly Journal of Economics, MIT Press, vol. 101(2), pages 211-28, May.
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  13. Christopher D Carroll, 2002. "Macroeconomic Expectations of Households and Professional Forecasters," Economics Working Paper Archive 477, The Johns Hopkins University,Department of Economics.
  14. Chinn, Menzie D. & Meese, Richard A., 1995. "Banking on currency forecasts: How predictable is change in money?," Journal of International Economics, Elsevier, vol. 38(1-2), pages 161-178, February.
  15. repec:ner:tilbur:urn:nbn:nl:ui:12-381116 is not listed on IDEAS
  16. Philippe Bacchetta & Eric van Wincoop, 2006. "Incomplete information processing: a solution to the forward discount puzzle," Working Paper Series 2006-35, Federal Reserve Bank of San Francisco.
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