The Role of Endogenous Uncertainty in the Forward Discount Bias

Stanley Wilkes Black ()
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Stanley Wilkes Black: Dimensional Fund Advisors LP, USA

Rivista Internazionale di Scienze Sociali, 2007, vol. 115, issue 3, 327-364

Abstract: This study examines what role the concept of endogenous uncertainty can have in explaining a phenomenon of international financial markets, the forward discount bias. The forward discount bias puzzle is unexplained by models assuming economic agents have full knowledge of the structure of the economy. This puzzle is explained here by constructing an overlapping generations model of a Rational Belief Equilibrium in a non-stationary environment where agents do not know the true probability distribution underlying asset price movements. The agents’ beliefs are rational in the sense that their predictions of long term averages of economic variables match historical data. The equilibrium of the model is solved numerically using the nonlinear equation solver TENSOLVE, which is well-suited to models containing multiple financial assets. The results confirm the underlying hypothesis that propagation of the beliefs of economic agents can play an important role in understanding international financial markets

Keywords: forward bias; forward discount bias; uncovered interest parity; exchange rates; market volatility; expectations; Rational Beliefs; heterogeneous beliefs; optimism (search for similar items in EconPapers)
JEL-codes: D5 D58 D8 D84 F3 F31 G15 (search for similar items in EconPapers)
Date: 2007
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:vep:journl:y:2007:v:115:i:3:p:327-364

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