Market Beliefs Research Articles

Rationality, Behavior and Switching Idiosyncracies in the Euro-Dollar Exchange Rate

This paper examines the determinants of the Euro-Dollar exchange rate, using the news approach to exchange rate modeling and some behavioral finance categories in the interpretation of its dynamics. A twice-daily frequency estimation was chosen, dividing the global trading day into an European Time Zone, ETZ (including also Asian trading), and an American Time Zone, ATZ. A new typology of news variables, unscheduled news, was employed, together with the traditional scheduled macroeconomic news. These former news, consisting of policy statements, market events, market beliefs, terror-related events turned out to be the main determinants of Euro-Dollar movements. Coefficient stability tests suggested to divide our 1999-2004 sample into three sub-periods roughly corresponding to the three phases of recent Euro history. The main finding of our analysis is the rejection of the semi-strong EMH once we move from the estimation over the entire sample to the three sub-periods. Here we find many lagged news variables to be significant, contrary to what EMH posits. The distribution of lagged news across time zones (ETZ and ATZ) and among the three sub-periods, indicates a substantial heterogeneity in the way news are decoded by market participants in the two trading zones and that exchange rates in ATZ react almost exclusively to American news, indicating that this zone influences the rest of the world but it is not affected by it. Scheduled news play a much bigger role in ATZ than in ETZ, especially the creation of new jobs in the US (the Non-farm Payroll). Exchange rate dynamics in ETZ is determined mostly by unscheduled news.

Alcohol policy and harm reduction in Australia

With consultations having been held across Australia this year as part of the process of developing a new National Alcohol Strategy, it seemed timely to invite my colleagues from the National Drug Research Institute who are experts in the alcohol field to write this Harm Reduction Digest. The authors have canvassed a range of alcohol policy options and discussed their effectiveness in reducing harm for what is arguably Australia's number one drug problem. Australia's response to alcohol and other drug problems has, historically, been based on 'harm minimization--incorporating supply reduction, demand reduction and harm reduction'. At this time where the policy options for alcohol are being set for the next 5 years in a climate of 'small government', removing restrictions of 'fair competition' in business and a belief in the free market, what does the research have to say about recommended policies and strategies to reduce alcohol-related harm?

The role of expectations in economic fluctuations and the efficacy of monetary policy

Diverse beliefs is an important mechanism for propagation of fluctuations, money nonneutrality and efficacy of monetary policy. Since expectations affect demand, our theory shows economic fluctuations are mostly driven by varying demand not supply shocks. Using a competitive model with flexible prices in which agents hold Rational Belief (see Kurz, 1994. Economic Theory 4, 877–900) we show that (i) our economy replicates well the empirical record of fluctuations in the U.S. (ii) Under monetary rules without discretion, monetary policy has a strong stabilization effect and an aggressive anti-inflationary policy can reduce inflation volatility to zero. (iii) The statistical Phillips curve changes substantially with policy instruments and activist policy rules render it vertical. (iv) Although prices are flexible, money shocks result in less than proportional change in inflation hence aggregate price level is ‘sticky’ with respect to money shocks. (v) Discretion in monetary policy adds a random element to policy and increases volatility. The impact of discretion on the efficacy of policy depends upon the structure of market beliefs about future discretionary decisions. We study two rationalizable beliefs. In one, market beliefs weaken the effect of policy and in the second, beliefs bolster policy outcomes and discretion could be a desirable attribute of the policy rule. Since the central bank does not know any more than the private sector, discretion is beneficial only in extraordinary cases. Hence, the weight of the argument suggests that policy should be transparent and abandon discretion except for rare circumstances. (vi) Our model suggests the current real policy is only mildly activist and aims mostly to target inflation.

From the Horse's Mouth: Gauging Conditional Expected Stock Returns from Investor Surveys

We use data obtained from a series of Michigan Surveys of Consumer Attitudes to study stock market beliefs and portfolio choices of individual investors. We find that expected returns over the medium- and long-term horizon appear to be extrapolated from past realized returns. The findings also indicate that a more optimistic assessment of macroeconomic conditions coincides with higher expected returns and lower expected volatility, implying strongly procyclical Sharpe ratios. These results are given added credence by the empirical finding that reported portfolio concentrations in equities tend to be higher for respondents who anticipate higher returns and lower uncertainty. Overall, our empirical results lend support to the hypothesis that equity valuations are lower during recessions--and subsequent returns are higher--because of undue pessimism about future returns, rather than high risk aversion.

Determinants of stock market volatility and risk premia

We show the dynamics of diverse beliefs is the primary propagation mechanism of volatility in asset markets. Hence, we treat the characteristics of the market beliefs as a primary, primitive, explanation of market volatility. We study an economy with stock and riskless bond markets and formulate a financial equilibrium model with diverse and time varying beliefs. Agents’ states of belief play a key role in the market, requiring an endogenous expansion of the state space. To forecast prices agents must forecast market states of belief which are beliefs of ‘‘others’’ hence our equilibrium embodies the Keynes ‘‘Beauty Contest.’’ A ‘‘market state of belief’’ is a vector which uniquely identifies the distribution of conditional probabilities of agents. Restricting beliefs to satisfy the rationality principle of Rational Belief (see Kurz, 1994, 1997) our economy replicates well the empirical record of the (i) moments of the price/dividend ratio, risky stock return, riskless interest rate and the equity premium; (ii) Sharpe ratio and the correlation between risky returns and consumption growth; (iii) predictability of stock returns and price/dividend ratio as expressed by: (I) Variance Ratio statistic for long lags, (II) autocorrelation of these variables, and (III) mean reversion of the risky returns and the predictive power of the price/dividend ratio. Also, our model explains the presence of stochastic volatility in asset prices and returns. Two properties of beliefs drive market volatility: (i) rationalizable over confidence implying belief densities with fat tails, and (ii) rationalizable asymmetry in frequencies of bull or bear states.

Government Discourses on Entrepreneurship: Issues of Legitimization, Subjugation, and Power

The belief in market–driven ideology and the assumption that new business ventures create jobs and foster innovation has embedded entrepreneurship into political discourse. Academics have analyzed government policies on entrepreneurship, but they have tended to share the same underlying beliefs in the function of entrepreneurs within the economic machine. This article explores selected dimensions of the impact of those beliefs by using critical discourse analysis to show how government websites around the world portray entrepreneurs and their role in society. Discourses of government power and self–legitimization are revealed that manifest themselves in a colonizing discourse of entrepreneurial subjugation. The article concludes by challenging government rhetoric on entrepreneurship and questioning the motives underpinning the agenda of government involvement in supporting entrepreneurs.

From the Horse's Mouth: Gauging Conditional Expected Stock Returns from Investor Surveys

We use data obtained from a series of Michigan Surveys of Consumer Attitudes to study stock market beliefs and portfolio choices of individual investors. We find that expected returns over the medium- and long-term horizon appear to be extrapolated from past realized returns. The findings also indicate that a more optimistic assessment of macroeconomic conditions coincides with higher expected returns and lower expected volatility, implying strongly procyclical Sharpe ratios. These results are given added credence by the empirical finding that reported portfolio concentrations in equities tend to be higher for respondents who anticipate higher returns and lower uncertainty. Overall, our empirical results lend support to the hypothesis that equity valuations are lower during recessions--and--subsequent returns are higher--because of undue pessimism about future returns, rather than high risk aversion.

Logarithmic Opinion Pools Violate the Unanimity Preservation Property

The aggregate of CARA individuals' beliefs takes the form of a logarithmic opinion pool in both market (composite market beliefs) and non-market (syndicate surrogate beliefs) settings. This paper shows that logarithmic opinion pools violate a minimal consistency requirement between individual- and aggregate-levels: the unanimity preservation property.

Optimal Transparency and Risk-Taking to Avoid Currency Crises

This paper reconsiders a central bank's problem of determining rules for information dissemination and risk-taking behavior that minimize the probability of currency crises. In a global-games approach, we find that optimal transparency is adversely related to prior market beliefs. In countries with pessimistic prior beliefs about economic performance, the central bank should commit to disclosing information with maximal precision. In addition, it should increase the risk of economic performance. For good prior expectations, posterior information should be of lower precision, depending on the variance of fundamentals. Here, the central bank can reduce the crisis probability by reducing that variance.

Media Meet the Citizen

Structural changes in the media world, including an increase in competition and commercialization, mean that the topicality and urgency of the notion of social responsibility in the media are increasing. Analogously, the discussion of the social responsibility of companies and organizations becomes a central concern in the business world and within government, as the relatively new concept of ‘good governance’ shows. In recent years we have seen that the absolute belief in the free market is once again under debate. Rather than a return to a controlling government as the main provider of a context in the complex ‘ecology’ of communication policy, possible solutions are now sought in greater responsibility for the media actors themselves (media companies and organizations, citizens, supervisory boards and commissions) and in self-regulation in the media profession. This article assesses accountability mechanisms currently in existence in the Netherlands and provides a comparative overview of interesting practices in other geographical contexts. This contribution also examines the academic reflection upon and conceptualization of such notions as social ‘responsibility’ and media ‘accountability’ in the division of labour throughout the market, the government and civil society. We are thinking of mechanisms for accountability such as a contract between the government and the broadcasters, an ombudsperson, forms of self-regulation, supervisory bodies, forms of public consultation, and the profession seeking contact with the citizens (e.g. civic journalism).

Prediction Markets

We analyze the extent to which simple markets can be used to aggregate disperse information into efficient forecasts of uncertain future events. Drawing together data from a range of prediction contexts, we show that market-generated forecasts are typically fairly accurate, and that they outperform most moderately sophisticated benchmarks. Carefully designed contracts can yield insight into the market's expectations about probabilities, means and medians, and also uncertainty about these parameters. Moreover, conditional markets can effectively reveal the market's beliefs about regression coefficients, although we still have the usual problem of disentangling correlation from causation. We discuss a number of market design issues and highlight domains in which prediction markets are most likely to be useful.

Endogenous uncertainty and the non-neutrality of money

We study some implications of the Theory of Rational Beliefs to monetary policy. We show that monetary policy in a Rational Beliefs environment can have an important effect on the characteristics of economic fluctuations. In Rational Beliefs Equilibria money is generically non-neutral unlike Rational Expectations Equilibria in which money is neutral and monetary policy is ineffective. Under Rational Beliefs Equilibria nominal prices and real output change not only in response to changes in the exogenous growth rate of money but also in response to changes in the state of beliefs. In Rational Beliefs Equilibria monetary shocks have real effects even when they are observed but are not fully anticipated. Furthermore, the non-neutrality of money results in a short run Phillips curve. When money “flutters, real output sputters” [8]. We show that Endogenous Uncertainty and the distribution of market beliefs are the major explanatory variables of such fluctuations. Under Rational Expectations monetary policy is ineffective because agents neutralize it by predicting correctly the effect of the policy. Under Rational Beliefs it is shown instead that inflation and recessions can be substantially aggravated by the distribution of market beliefs.

Anticipating Bailouts: The Incentive-Conflict Model and the Collapse of the Ohio Deposit Guarantee Fund

The collapse of the Ohio Deposit Guarantee Fund in March 1985 provides a laboratory for examining the financial market's belief in the incentive-conflict model proposed by Kane (1989). Research in this area has yet to examine the stock returns of federally insured institutions during that period in the context of this model. Thus, it has not addressed the question of whether financial market participants recognize the implications of the model; that is, whether they anticipate the bailouts it implies. This paper fills that void. We find that on average, stocks of firms insured by the poorly capitalized FSLIC do reasonably well during the 41-day event window centered on the ODGF's Bank Holiday, while stocks of firms insured by the relatively well-capitalized FDIC do not. More important, differences in abnormal returns of FDIC and FSLIC firms are consistent with a reaffirmation of the incentive-conflict model.

The Role of Expectations in Economic Fluctuations and the Efficacy of Monetary Policy

We show diverse beliefs is an important propagation mechanism of fluctuations, money non neutrality and efficacy of monetary policy. Since expectations affect demand, our theory shows economic fluctuations are mostly driven by varying demand not supply shocks. Using a competitive model with flexible prices in which agents hold Rational Belief (see Kurz (1994)) we show that (i) our economy replicates well the empirical record of fluctuations in the U.S. (ii) Under monetary rules without discretion, monetary policy has a strong stabilization effect and an aggressive anti-inflationary policy can reduce inflation volatility to zero. (iii) The statistical Phillips Curve changes substantially with policy instruments and activist policy rules render it vertical. (iv) Although prices are flexible, money shocks result in less than proportional changes in inflation hence the aggregate price level appears sticky with respect to money shocks. (v) Discretion in monetary policy adds a random element to policy and increases volatility. The impact of discretion on the efficacy of policy depends upon the structure of market beliefs about future discretionary decisions. We study two rationalizable beliefs. In one case, market beliefs weaken the effect of policy and in the second, beliefs bolster policy outcomes and discretion could be a desirable attribute of the policy rule. Since the central bank does not know any more than the private sector, real social gain from discretion arise only in extraordinary cases. Hence, the weight of the argument leads us to conclude that bank's policy should be transparent and abandon discretion except for rare and unusual circumstances. (vi) An implication of our model suggests the current effective policy is only mildly activist and aims mostly to target inflation.

Forecasting Emerging Market Exchange Rates from Foreign Equity Options

AbstractThe use of derivatives to infer future exchange rates has long been a subject of interest in the international finance literature. With the recent currency crises in Mexico, Southeast Asia, and Brazil, work on exchange rate expectations in emerging markets is of particular interest. For some emerging markets, foreign equity options are the only liquid exchange‐traded derivatives with currency information embedded in their prices. Given that emerging markets sometimes undergo currency realignment with discrete jumps in their exchange rate, estimation of risk‐neutral probability density functions from foreign equity option data provides valuable evidence concerning market expectations. To illustrate the use of foreign equity options in estimating market beliefs, we consider Telmex options around the 1994 peso devaluation and find evidence that markets anticipated the change in the Mexican government's foreign exchange policy.

THE ENTROPY THEORY OF BOND OPTION PRICING

An informationally efficient price keeps investors as a group in the state of maximum uncertainty about the next price change. The Entropy Pricing Theory (EPT) captures this intuition and suggests that, in informationally efficient markets, perfectly uncertain market beliefs must prevail. When the entropy functional is used to index collective market uncertainty, then the entropy-maximizing consensus beliefs must prevail. The EPT resolves the ambiguity of arbitrage-free valuation in incomplete markets. The EPT produces a new bond option model that is similar to Black–Scholes' with the lognormal distribution replaced by a beta distribution. Unlike alternative models, the beta model is valid for arbitrary term structure dynamics and for arbitrary credit risk of the underlying bonds. Option replication and hedging under the beta model accounts for random changes in the underlying bond price, price volatility and short-term interest rates.

Rational Beliefs and Security Design

This article studies the security-design problem of a cash-constrained firm facing investors with diverse beliefs. Investor “rational beliefs” are modeled as varying and yet rational in the sense of Kurz (1994a). With two investors, optimal designs are similar under rational beliefs and rational expectations. With many investors, however, optimal securities under rational beliefs maximize investor differences of opinion, while under rational expectations optimal designs minimize disagreements. We demonstrate that the common practice of issuing multiple securities backed by a single asset is optimal under rational beliefs but not under rational expectations. Researching market beliefs can create substantial value for firms.

Administering market friendly growth? Liberal populism and the World Bank's involvement in administrative reform in sub-Saharan Africa

This article critically analyses recent innovations in the World Bank's thinking on administrative reform as part of a broader set of notions contained within the international 'governance agenda'. It is argued that the Bank's administrative reform literature generates a discourse of liberal populism. Liberal populism keys in with i) a fundamental belief in the free market as a means towards development and stability, and ii) recent innovations towards inclusion, participation and stakeholding which are prominent in the administrative reform literature. The article finishes by relating this discourse to the political economy of structural adjustment and indebtedness to suggest that this discourse might be subject to the same processes of revision and selective abandonment that have characterized many other Bank prioritizations over the decades.

Administering market friendly growth? Liberal populism and the World Bank's involvement in administrative reform in sub-Saharan Africa

This article critically analyses recent innovations in the World Bank's thinking on administrative reform as part of a broader set of notions contained within the international 'governance agenda'. It is argued that the Bank's administrative reform literature generates a discourse of liberal populism. Liberal populism keys in with i) a fundamental belief in the free market as a means towards development and stability, and ii) recent innovations towards inclusion, participation and stakeholding which are prominent in the administrative reform literature. The article finishes by relating this discourse to the political economy of structural adjustment and indebtedness to suggest that this discourse might be subject to the same processes of revision and selective abandonment that have characterized many other Bank prioritizations over the decades.

Continuing education needs assessment for on-farm food safety services.

To identify the perceived market or client demand for dairy on-farm food safety services by veterinarians, the need for a food safety continuing education program, and the educational issues that might be addressed in an on-farm food safety curriculum. Survey. Consulting dairy veterinarians, government veterinarians located in California, and meat packers slaughtering cull dairy cows in California. Results of a questionnaire supplied to veterinarians and telephone interviews with meat packer representatives were analyzed by use of univariate and multivariate logistic regression procedures. Some meat packers considered the quality of incoming cull dairy cattle as a control point for food safety hazards. More than 50% of dairy and government-employed veterinarians believed that a current market for on-farm food safety services exists; > 85% believed that a potential market exists. Duration since graduation was negatively correlated with belief in a current market. Government-employed veterinarians were more likely to believe in a current market. Veterinarians were more likely to express a strong interest in offering on-farm food safety services if they believed a current market exists, indicated that they already offer such services, or listed residues and pathogens as the most important issues facing the dairy industry. Although a potential market for on-farm food safety services is perceived, veterinarians are unsure of their role in this area. new demands of meat packers slaughtering cull dairy cows may be the motivation practitioners need to broach the subject of food safety with clients.