The Permanent-Transitory Confusion: Implications for Tests of Market Efficiency and for Expected Inflation During Turbulent and Tranquil Times

31 Pages Posted: 24 Sep 2018 Last revised: 12 Nov 2018

See all articles by Alex Cukierman

Alex Cukierman

Tel Aviv University - Eitan Berglas School of Economics; Interdisciplinary Center (IDC) Herzliyah; Centre for Economic Policy Research (CEPR)

Thomas Lustenberger

Swiss National Bank; University of Basel - Faculty of Business and Economics

Allan H. Meltzer

Carnegie Mellon University - David A. Tepper School of Business

Date Written: September 2018

Abstract

Even when all past and present information is known individuals usually remain uncertain about the permanence of observed variables. After reviewing the history and role of adaptive expectations and its statistical foundations in modeling this permanent-transitory confusion the paper investigates the consequences of this confusion for tests of market efficiency in the treasury bill and foreign exchange markets. A central result is that the detection of serial correlation in efficiency tests based on finite samples does not necessarily imply that markets are inefficient. The second part of the paper utilizes data on Israeli inflation expectations from the capital market to estimate the implicit speed of learning about changes in inflation and to examine the performance of adaptive expectations in tracking the evolution of those expectations during the 1985 Israeli shock stabilization as well as during the stable inflation targeting period.

Keywords: behavior of inflationary expectations during stabilizations and tranquil times, Permanent-transitory confusion and rational expectations, tests of market efficiency in treasury bills and forex markets

JEL Classification: B16, B22, E31, G14

Suggested Citation

Cukierman, Alex and Lustenberger, Thomas and Lustenberger, Thomas and Meltzer, Allan H., The Permanent-Transitory Confusion: Implications for Tests of Market Efficiency and for Expected Inflation During Turbulent and Tranquil Times (September 2018). Available at SSRN: https://ssrn.com/abstract=3254222

Alex Cukierman (Contact Author)

Tel Aviv University - Eitan Berglas School of Economics ( email )

P.O. Box 39040
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Interdisciplinary Center (IDC) Herzliyah ( email )

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HOME PAGE: http://www.tau.ac.il/~alexcuk/

Centre for Economic Policy Research (CEPR)

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Thomas Lustenberger

Swiss National Bank

Research
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University of Basel - Faculty of Business and Economics ( email )

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Allan H. Meltzer

Carnegie Mellon University - David A. Tepper School of Business ( email )

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