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Explaining Forward Discount Bias: Is it Anchoring?

  • David W.R. Gruen

    (Reserve Bank of Australia)

  • Marianne C. Gizycki

    (Reserve Bank of Australia)

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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