Change and expectations in macroeconomic models: recognizing the limits to knowability

Frydman, Roman; Goldberg, Michael

doi:10.1080/1350178x.2013.804677

Cited by 11 publications

(1 citation statement)

References 45 publications

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“…21), on Swiss-US data (Juselius and Assenmacher 2017) and on UK-US data (Juselius and Stillwagon 2017). Because of this, it seems that the key for understanding these long swings in exchange rates and interest rates (both real and nominal) is to recognize the importance of imperfect knowledge, reflexivity, and positive and negative feedback mechanisms (Soros 1987;Frydman and Goldberg 2013;Hands 2013;Hommes 2013).…”

Section: Discussionmentioning

confidence: 99%

Using a Theory-Consistent CVAR Scenario to Test an Exchange Rate Model Based on Imperfect Knowledge

Jusélius

2017

Econometrics

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A theory-consistent CVAR scenario describes a set of testable regularieties one should expect to see in the data if the basic assumptions of the theoretical model are empirically valid. Using this method, the paper demonstrates that all basic assumptions about the shock structure and steady-state behavior of an an imperfect knowledge based model for exchange rate determination can be formulated as testable hypotheses on common stochastic trends and cointegration. This model obtaines remarkable support for almost every testable hypothesis and is able to adequately account for the long persistent swings in the real exchange rate.

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Section: Discussionmentioning

confidence: 99%

Using a Theory-Consistent CVAR Scenario to Test an Exchange Rate Model Based on Imperfect Knowledge

Jusélius

2017

Econometrics

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Real exchange rate persistence and the excess return puzzle: The case of Switzerland versus the US

Jusélius

Assenmacher

2017

J of Applied Econometrics

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The PPP puzzle refers to the wide swings of nominal exchange rates around their long-run equilibrium values whereas the excess return puzzle represents the persistent deviation of the domestic-foreign interest rate differential from the expected change in the nominal exchange rate. Using the I(2) cointegrated VAR model, much of the excess return puzzle disappears when an uncertainty premium in the foreign exchange market, proxied by the persistent PPP gap, is introduced. Self-reinforcing feedback mechanisms seem to cause the persistence in the Swiss-US parity conditions. These results support imperfect knowledge based expectations rather than so-called "rational expectations". INTRODUCTIONIt is a well-established fact that the ratio of domestic to foreign goods prices typically changes only slowly while the nominal exchange rate undergoes large, persistent swings. As a result, both the real and the nominal exchange rate exhibit large swings away from and towards long-run benchmark values. These long swings around long-run fundamental values are hard to reconcile with standard monetary models based on Rational Expectations (RE) and a representative agent endowed with essentially perfect knowledge. 1 In the literature, alternative approaches that rely on heterogeneous agents and imperfect knowledge have been proposed. We call these "imperfect knowledge" based models in contrast to the conventional RE representative agent models. Common to these models is that today's asset price depends on future prices which, in varying degree, are forecast under imperfect knowledge and, thus, can deviate from the expected future prices as derived under RE. For example, Hommes (2005) and Hommes, Huang, and Wang (2005) and Hommes, Sonnemans, Tuinstra, and van de Velden (2005) developed models for a financial market populated by fundamentalists and chartists where fundamentalists use long-term expectations based on economic fundamentals and chartists are trend-followers using short-term expectations. 2 Positive feedback prevails when the latter dominate the market. In these models agents switch endogenously between a mean-reverting fundamentalist and a trend-following chartist strategy. The models were estimated by using a non-linear AR(1) model with a time-varying coefficient supposed to capture market sentiment. 3 By contrast, we shall use the I(2) CVAR model to capture the effect of dominant trend-followers formulated as error-increasing behavior away from long-run fundamental values (positive feedback) and the reversal to fundamental values as error-correcting behavior (negative feedback).Adam and Marcet (2011) proposed a separation of standard RE rationality into an internal and an external component. They showed that positive feedback can arise in a model where internal rationality is maintained but external rationality is relaxed due to imperfect market knowledge. Heemeijer, Hommes, Sonnemans, and Tuinstra (2009) used experiments and found that prices converge to their fundamental level under negative feedback but fail to d...

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Rational populists: the social consequences of shared narratives

et al. 2020

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Change and expectations in macroeconomic models: recognizing the limits to knowability

Cited by 11 publications

References 45 publications

Using a Theory-Consistent CVAR Scenario to Test an Exchange Rate Model Based on Imperfect Knowledge

Using a Theory-Consistent CVAR Scenario to Test an Exchange Rate Model Based on Imperfect Knowledge

Real exchange rate persistence and the excess return puzzle: The case of Switzerland versus the US

Rational populists: the social consequences of shared narratives

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