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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. Philippe Bacchetta & Eric van Wincoop, 2006. "Incomplete information processing: a solution to the forward discount puzzle," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  2. Gordon Menzies & Daniel John Zizzo, 2004. "Inferential Expectations," Economics Series Working Papers 187, University of Oxford, Department of Economics.
  3. Goldberg, Michael D & Frydman, Roman, 1996. "Imperfect Knowledge and Behaviour in the Foreign Exchange Market," Economic Journal, Royal Economic Society, vol. 106(437), pages 869-93, July.
  4. Christopher D Carroll, 2002. "Macroeconomic Expectations of Households and Professional Forecasters," Economics Working Paper Archive 477, The Johns Hopkins University,Department of Economics.
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  8. 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.
  9. N. Gregory Mankiw & Jeffrey A. Miron, 1985. "The Changing Behavior of the Term Structure of Interest Rates," NBER Working Papers 1669, National Bureau of Economic Research, Inc.
  10. Eric Fisher, 2004. "Exploring Elements of Exchange Rate Theory in a Controlled Enivronment," Levine's Bibliography 122247000000000199, UCLA Department of Economics.
  11. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  12. 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.
  13. Swenson, Charles W., 1997. "Rational expectations and tax policy: Experimental market evidence," Journal of Economic Behavior & Organization, Elsevier, vol. 32(3), pages 433-455, March.
  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. Olivier Jean Blanchard & Stanley Fischer, 1989. "Lectures on Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262022834, June.
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