Inefficiency and predictability in the Brexit Pound market: a natural experiment

Swiss Finance Institute Research Paper No. 17-12

The European Journal of Finance, DOI: 10.1080/1351847X.2020.1805781, pp. 1-21 (2020)

22 Pages Posted: 29 Mar 2017 Last revised: 24 Aug 2020

See all articles by Ke Wu

Ke Wu

Southern University of Science and Technology; ETH Zurich - Department of Management, Technology, and Economics (D-MTEC)

Spencer Wheatley

ETH Zürich

Didier Sornette

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC); Swiss Finance Institute; Southern University of Science and Technology; Tokyo Institute of Technology

Date Written: January 8, 2019

Abstract

Exploiting the near-experimental conditions provided by the GBPUSD exchange rate during the Brexit vote of 2016, we quantify a significant delay of the market price in reflecting the increasing probability of a Brexit outcome over the vote counting period. We claim that the Brexit outcome could realistically have been predicted hours before the market adjusted to the outcome. This inefficiency is identified by comparing the market-implied probability of a Brexit outcome with a separate probability, estimated by a standard Monte-Carlo algorithm based on a simple linear regression model, representative of what should have been easily possible in real time. The core of the method is the real-time re-calibration of ex-ante ‘pollster’ predictions for the voting district outcomes by regressing the observed voting results onto them. For comparative purposes, a study of the MXNUSD exchange rate in the 2016 US Presidential Election was done, finding that the market-implied and model-estimated probabilities moved more consistently toward the Trump outcome. Put together, this identifies a somewhat anomalous breakdown in market efficiency in the case of the Brexit vote, which we attribute to its novelty as well as a kind of political bubble and subsequent crash, generated by confirmation bias and social herding.

Keywords: Prediction, natural experiment, market failure, efficient market hypothesis

JEL Classification: C53, D72, G17, C51

Suggested Citation

Wu, Ke and Wheatley, Spencer and Sornette, Didier, Inefficiency and predictability in the Brexit Pound market: a natural experiment (January 8, 2019). Swiss Finance Institute Research Paper No. 17-12, The European Journal of Finance, DOI: 10.1080/1351847X.2020.1805781, pp. 1-21 (2020), Available at SSRN: https://ssrn.com/abstract=2940173 or http://dx.doi.org/10.2139/ssrn.2940173

Ke Wu

Southern University of Science and Technology ( email )

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ETH Zurich - Department of Management, Technology, and Economics (D-MTEC) ( email )

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Spencer Wheatley

ETH Zürich ( email )

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Switzerland

Didier Sornette (Contact Author)

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC) ( email )

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Zurich, ZURICH CH-8092
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41446321914 (Fax)

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Swiss Finance Institute

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Southern University of Science and Technology

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Shenzhen, Guangdong 518055
China

Tokyo Institute of Technology

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