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What explains deviations in the unbiased expectations hypothesis? Market irrationality vs. the peso problem

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  • Chen, Cathy Yi-Hsuan
  • Kuo, I-Doun
  • Chiang, Thomas C.

Abstract

Evidence from this study suggests that investor sentiment and the peso problem play a significant role in explaining expectation errors, rejecting the unbiased expectation hypothesis (UEH). The deviation of the UEH for long-term rates is mainly attributable to expectation errors, whereas the deviation of short-term rates is tied to the term premium. We decompose expectation errors and find that irrationality is more apparent in crisis periods, and the rational component becomes an influential factor in tranquil periods.

Suggested Citation

  • Chen, Cathy Yi-Hsuan & Kuo, I-Doun & Chiang, Thomas C., 2014. "What explains deviations in the unbiased expectations hypothesis? Market irrationality vs. the peso problem," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 30(C), pages 172-190.
    • Handle: RePEc:eee:intfin:v:30:y:2014:i:c:p:172-190
    DOI: 10.1016/j.intfin.2014.01.009
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    Cited by:

    1. Cathy Yi-Hsuan Chen & Thomas C. Chiang, 2017. "Surprises, sentiments, and the expectations hypothesis of the term structure of interest rates," Review of Quantitative Finance and Accounting, Springer, vol. 49(1), pages 1-28, July.
    2. Tsuchiya, Yoichi, 2016. "Asymmetric loss and rationality of Chinese renminbi forecasts: An implication for the trade between China and the US," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 44(C), pages 116-127.

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    More about this item

    Keywords

    Expectations hypothesis; Term structure of interest rates; Sentiment; Expectation error; Peso problem;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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