Exchange Rate Markets and Conservative Inferential Expectations

65 Pages Posted: 18 Dec 2006

See all articles by Gordon Douglas Menzies

Gordon Douglas Menzies

University of Technology Sydney (UTS) - School of Finance and Economics

Daniel John Zizzo

University of Queensland - School of Economics

Date Written: December 2006

Abstract

We present a macroeconomic market experiment on the financial determination of exchange rates, and consider whether the assumption that belief formation be treated as a classical hypothesis test, which we label inferential expectations, can explain the effect of uncertainty on exchange rates. In a non-stochastic environment, exchange rates closely follow standard predictions. In our stochastic environment, inferential expectations with a low test size alpha (conservative inferential expectations) predict exchange rates better than rational expectations in ten sessions out of twelve. Belief conservatism appears magnified rather than diminished at the market level, and the degree of belief conservatism seems connected to the failure of uncovered interest rate parity regressions.

Keywords: exchange rates, market experiments, belief conservatism, expectations, uncovered interest parity

JEL Classification: C91, D84, E50, F31

Suggested Citation

Menzies, Gordon Douglas and Zizzo, Daniel John, Exchange Rate Markets and Conservative Inferential Expectations (December 2006). Available at SSRN: https://ssrn.com/abstract=952347 or http://dx.doi.org/10.2139/ssrn.952347

Gordon Douglas Menzies

University of Technology Sydney (UTS) - School of Finance and Economics ( email )

Haymarket
Sydney, NSW 2007
Australia

Daniel John Zizzo (Contact Author)

University of Queensland - School of Economics ( email )

St Lucia
Brisbane, Queensland 4072
Australia

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