The Role of Beliefs in Asset Prices: Evidence from Exchange Rates

78 Pages Posted: 23 Jul 2021 Last revised: 25 Apr 2022

See all articles by Joao Paulo Valente

Joao Paulo Valente

Yale University, Department of Economics, Students

Kaushik Vasudevan

Yale University

Tianhao Wu

Yale University, Department of Economics, Students

Date Written: April 12, 2022

Abstract

A long-standing question is why asset prices sometimes underreact and sometimes overreact to news. We explore this question in currency markets. We use survey data to estimate a model featuring investors with noisy private information and extrapolative beliefs about interest rates, and find the estimated model quantitatively matches patterns of initial underreaction and delayed overreaction of currencies in response to interest rate news. The model also helps explain changes in the time-series predictability of currency returns by interest rates in recent years, the term structure of UIP deviations, and additional features of beliefs in survey data. Our results highlight the role of investors' beliefs in asset price behavior.

Suggested Citation

Valente, Joao Paulo and Vasudevan, Kaushik and Wu, Tianhao, The Role of Beliefs in Asset Prices: Evidence from Exchange Rates (April 12, 2022). Available at SSRN: https://ssrn.com/abstract=3872077 or http://dx.doi.org/10.2139/ssrn.3872077

Joao Paulo Valente

Yale University, Department of Economics, Students ( email )

28 Hillhouse Ave
New Haven, CT 06520-8268
United States

Kaushik Vasudevan (Contact Author)

Yale University ( email )

165 Whitney Avenue
New Haven, CT 06511
United States

HOME PAGE: http://www.kvasudevan.com

Tianhao Wu

Yale University, Department of Economics, Students ( email )

28 Hillhouse Ave
New Haven, CT 06520-8268
United States

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