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Inferential Expectations

We propose that the formation of beliefs be treated as statistical hypothesis tests, and we label such beliefs inferential expectations. If a belief is overturned through the build-up of evidence, agents are assumed to switch to the rational expectation. Rational expectations are shown to be a special (limiting) case of inferential expectations, with the test size a becoming a metric for rationality. When inferential expectations are built into a Dornbusch-style model of the exchange rate, regression tests of Uncovered Interest Parity and the rational expectations version of the term structure both display downward bias in the slope coefficient. We present the results of an experiment that supports inferential expectations.

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File URL: http://www.qfrc.uts.edu.au/research/research_papers/rp159.pdf
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Paper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 159.

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Length: 41 pages
Date of creation: 01 May 2005
Date of revision:
Publication status: Published as: Menzies, G. and Zizzo, J., 2009, "Inferential Expectations", The B.E. Journal of Macroeconomics, 9(1), 1-27.
Handle: RePEc:uts:rpaper:159
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  2. Mankiw, N. Gregory & Reis, Ricardo, 2002. "Sticky Information Versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," Scholarly Articles 3415324, Harvard University Department of Economics.
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  11. Stefan Gerlach & Frank Smets, 1995. "The term structure of Euro-rates: some evidence in support of the expectations hypothesis," BIS Working Papers 28, Bank for International Settlements.
  12. 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.
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  17. Rappoport, Peter, 1985. "Unfalsified Expectations: An Alternative Perspective on Modelling Expectations in Macroeconomics," Working Papers 85-16, C.V. Starr Center for Applied Economics, New York University.
  18. Steven Radelet & Jeffrey Sachs, 1998. "The Onset of the East Asian Financial Crisis," NBER Working Papers 6680, National Bureau of Economic Research, Inc.
  19. Bossaerts, Peter & Bodarenko, Oleg, 1997. "Expectations and Learning in Iowa," Working Papers 989, California Institute of Technology, Division of the Humanities and Social Sciences.
  20. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  21. Michael Woodford, 1994. "Structural Slumps," Journal of Economic Literature, American Economic Association, vol. 32(4), pages 1784-1815, December.
  22. Akerlof, George A & Yellen, Janet L, 1985. "Can Small Deviations from Rationality Make Significant Differences to Economic Equilibria?," American Economic Review, American Economic Association, vol. 75(4), pages 708-20, September.
  23. Frankel, Jeffrey A & Froot, Kenneth A, 1987. "Using Survey Data to Test Standard Propositions Regarding Exchange Rate Expectations," American Economic Review, American Economic Association, vol. 77(1), pages 133-53, March.
  24. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
  25. 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.
  26. Zellner, Arnold, 1988. "Bayesian analysis in econometrics," Journal of Econometrics, Elsevier, vol. 37(1), pages 27-50, January.
  27. N. Gregory Mankiw & Ricardo Reis, 2001. "Sticky Information: A Model of Monetary Nonneutrality and Structural Slumps," NBER Working Papers 8614, National Bureau of Economic Research, Inc.
  28. George A. Akerlof, 2002. "Behavioral Macroeconomics and Macroeconomic Behavior," American Economic Review, American Economic Association, vol. 92(3), pages 411-433, June.
  29. Gruen, David W R & Menzies, Gordon D, 1995. "Forward Discount Bias: Is It Near-Rationality in the Foreign Exchange Market?," The Economic Record, The Economic Society of Australia, vol. 71(213), pages 157-66, June.
  30. Gourinchas, Pierre-Olivier & Tornell, Aaron, 2004. "Exchange rate puzzles and distorted beliefs," Journal of International Economics, Elsevier, vol. 64(2), pages 303-333, December.
  31. Beckman, Steven R. & Downs, David, 1997. "Forecasters as imperfect information processors: Experimental and survey evidence," Journal of Economic Behavior & Organization, Elsevier, vol. 32(1), pages 89-100, January.
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