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383
New Techniques to Extract Market Expectations from Financial Instruments
 Journal of Monetary Economics
, 1997
"... Central banks have several reasons for extracting information from asset prices. Asset prices may embody more accurate and more uptodate macroeconomic data than what is currently published or directly available to policy makers. Aberrations in some asset prices may indicate ..."
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Cited by 141 (4 self)
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Central banks have several reasons for extracting information from asset prices. Asset prices may embody more accurate and more uptodate macroeconomic data than what is currently published or directly available to policy makers. Aberrations in some asset prices may indicate
Using OutofSample Mean Squared Prediction Errors to Test the Martingale Difference Hypothesis
, 2004
"... We consider using outofsample mean squared prediction errors (MSPEs) to evaluate the null that a given series follows a zero mean martingale difference against the alternative that it is linearly predictable. Under the null of no predictability, the population MSPE of the null “no change” model eq ..."
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Cited by 116 (14 self)
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We consider using outofsample mean squared prediction errors (MSPEs) to evaluate the null that a given series follows a zero mean martingale difference against the alternative that it is linearly predictable. Under the null of no predictability, the population MSPE of the null “no change” model equals that of the linear alternative. We show analytically and via simulations that despite this equality, the alternative model’s sample MSPE is expected to be greater than the null’s. For rolling regression estimators of the alternative model’s parameters, we propose and evaluate an asymptotically normal test that properly accounts for the upward shift of the sample MSPE of the alternative model. Our simulations indicate that our proposed procedure works well.
Evaluating an Estimated New Keynesian Small Open Economy Model,” Journal of Economic Dynamics and Control, forthcoming
, 2006
"... This paper estimates and tests a new Keynesian small open economy model in the tradition of Christiano, Eichenbaum, and Evans (2005) and Smets and Wouters (2003) using Bayesian estimation techniques on Swedish data. To account for the switch to an inflation targeting regime in 1993 we allow for a d ..."
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Cited by 104 (16 self)
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This paper estimates and tests a new Keynesian small open economy model in the tradition of Christiano, Eichenbaum, and Evans (2005) and Smets and Wouters (2003) using Bayesian estimation techniques on Swedish data. To account for the switch to an inflation targeting regime in 1993 we allow for a discrete break in the central bank’s instrument rule. The empirical results indicate that allowing for such a regime shift is indeed supported by the data. A key equation in the model the uncovered interest rate parity (UIP) condition is well known to be rejected empirically. Therefore we explore the consequences of modifying the UIP condition to allow for a negative correlation between the risk premium and the expected change in the nominal exchange rate. The results show that the modification increases the persistence in the real exchange rate and that this model has an empirical advantage compared with the standard UIP specification.
Investor psychology in capital markets: evidence and policy implications
, 2002
"... We review extensive evidence about how psychological biases affect investor behavior and prices. Systematic mispricing probably causes substantial resource misallocation. We argue that limited attention and overconfidence cause investor credulity about the strategic incentives of informed market par ..."
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Cited by 93 (22 self)
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We review extensive evidence about how psychological biases affect investor behavior and prices. Systematic mispricing probably causes substantial resource misallocation. We argue that limited attention and overconfidence cause investor credulity about the strategic incentives of informed market participants. However, individuals as political participants remain subject to the biases and selfinterest they exhibit in private settings. Indeed, correcting contemporaneous market pricing errors is probably not government’s relative advantage. Government and private planners should establish rules ex ante to improve choices and efficiency, including disclosure, reporting, advertising, and defaultoptionsetting regulations. Especially
Towards a solution to the puzzles in exchange rate economics: where do we stand?, Canadian
 Journal of Economics
, 2005
"... This paper provides a selective overview of puzzles in exchange rate economics. We begin with the forward bias puzzle: high interest rate currencies appreciate when one might guess that investors would demand higher interest rates on currencies expected to fall in value. We then analyze the purchasi ..."
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Cited by 83 (2 self)
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This paper provides a selective overview of puzzles in exchange rate economics. We begin with the forward bias puzzle: high interest rate currencies appreciate when one might guess that investors would demand higher interest rates on currencies expected to fall in value. We then analyze the purchasing power parity puzzle: the real exchange rate displays no (strong) reversion to a stable longrun equilibrium level. Finally, we cover the exchange rate disconnect puzzle: the lack of a link between the nominal exchange rate and economic fundamentals. For each puzzle, we critically review the literature and speculate on potential solutions. JEL classification: F31.
FX Trading and Exchange Rate Dynamics
, 2001
"... This paper provides new perspective on the poor performance of exchange rate models by focusing on the information structure of FX trading. I present a new theoretical model of FX trading that emphasizes the role of incomplete and heterogeneous information. The model shows how an equilibrium distr ..."
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Cited by 65 (9 self)
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This paper provides new perspective on the poor performance of exchange rate models by focusing on the information structure of FX trading. I present a new theoretical model of FX trading that emphasizes the role of incomplete and heterogeneous information. The model shows how an equilibrium distribution of FX transaction prices and orders can arise at each point in time from the optimal trading decisions of dealers. This result motivates an empirical investigation of how the equilibrium distribution of FX prices behaves using a new data set that details trading activity in the FX market. This analysis produces two striking results: (i) Much of the observed shortterm volatility in exchange rates comes from sampling the heterogeneous trading decisions of dealers in an equilibrium distribution that, under normal market conditions, changes comparatively slowly. (ii) In contrast to the assumptions of traditional macro models, public news is rarely the predominant source of exchange rate movements over any horizon.
The (partial) rehabilitation of interest rate parity in the floating rate era: Longer horizons, alternative expectations, and emerging markets
, 2006
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TimeVarying Risk, Interest Rates, and Exchange Rates in General Equilibrium
, 2005
"... Timevarying risk is the primary force driving nominal interest rate differentials on currencydenominated bonds. This finding is an immediate implication of the fact that exchange rates are roughly random walks. We show that a general equilibrium monetary model with an endogenous source of risk vari ..."
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Cited by 56 (6 self)
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Timevarying risk is the primary force driving nominal interest rate differentials on currencydenominated bonds. This finding is an immediate implication of the fact that exchange rates are roughly random walks. We show that a general equilibrium monetary model with an endogenous source of risk variation–a variable degree of asset market segmentation–can produce key features of actual interest rates and exchange rates. The endogenous segmentation arises from a fixed cost for agents to exchange money for assets. As inflation varies, the benefit ofassetmarketparticipation varies, and that changes the fraction of agents participating. These effects lead the risk premium to vary systematically with the level of inflation. Our model produces variation in the risk premium even though the fundamental shocks have constant conditional variances.