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An experimental test of trade hysteresis: market exit and entry decisions in the presence of sunk costs and exchange rate uncertainty

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  • David Ansic
  • Geoffrey Pugh

Abstract

In the 1980s, the unresponsiveness of trade flows to exchange rate swings inspired models in which sunk costs in combination with exchange rate instability generate trade hysteresis, meaning that temporary exchange rate misalignments have a persistent effect on trade. This paper furnishes an empirical complement to the theoretical literature. First, it describes a computerized experiment in which 100 subjects generated over 1000 decisions on market entry and exit under conditions congruent with a model of trade hysteresis developed by Paul Krugman. Secondly, these data are used to test the main predictions arising from the model. Our experiment bears out the main qualitative predictions of Krugman's model; in particular, that firms' trading policy is unresponsive to exchange rate movements over a wide range of values. Moreover, in the repeated-decision setting of the experiment, we find evidence that the stochastic behaviour of subjects' entry- and exit-price decisions tend towards consensus as they gain experience, even though they do not interact with one another during the experiment. This effect, which is not predicted in Krugman's model, supports the supposition that behaviour at the firm level in the presence of sunk costs and exchange rate uncertainty is a plausible microeconomic foundation for otherwise puzzling macroeconomic phenomena.

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  • David Ansic & Geoffrey Pugh, 1999. "An experimental test of trade hysteresis: market exit and entry decisions in the presence of sunk costs and exchange rate uncertainty," Applied Economics, Taylor & Francis Journals, vol. 31(4), pages 427-436.
    • Handle: RePEc:taf:applec:v:31:y:1999:i:4:p:427-436
    DOI: 10.1080/000368499324138
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    References listed on IDEAS

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    1. Baldwin, Richard, 1988. "Hyteresis in Import Prices: The Beachhead Effect," American Economic Review, American Economic Association, vol. 78(4), pages 773-785, September.
    2. Charles Bean, 1988. "Sterling Misalignment and British Trade Performance," NBER Chapters, in: Misalignment of Exchange Rates: Effects on Trade and Industry, pages 39-76, National Bureau of Economic Research, Inc.
    3. Richard Baldwin, 1988. "Some Empirical Evidence on Hysteresis in Aggregate US Import Prices," NBER Working Papers 2483, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Dean A. Shepherd & Holger Patzelt & Trenton A. Williams & Dennis Warnecke, 2014. "How Does Project Termination Impact Project Team Members? Rapid Termination, ‘Creeping Death’, and Learning from Failure," Journal of Management Studies, Wiley Blackwell, vol. 51(4), pages 513-546, June.
    2. Daniel W. Elfenbein & Anne Marie Knott & Rachel Croson, 2017. "Equity stakes and exit: An experimental approach to decomposing exit delay," Strategic Management Journal, Wiley Blackwell, vol. 38(2), pages 278-299, February.
    3. Marvin B. Lieberman & Gwendolyn K. Lee & Timothy B. Folta, 2017. "Entry, exit, and the potential for resource redeployment," Strategic Management Journal, Wiley Blackwell, vol. 38(3), pages 526-544, March.
    4. Murat Isik, 2005. "Incorporating decision makers' risk preferences into real options models," Applied Economics Letters, Taylor & Francis Journals, vol. 12(12), pages 729-734.
    5. Axarloglou, Kostas & Kouvelis, Panos, 2007. "Hysteresis in adjusting the ownership structure of foreign subsidiaries," International Business Review, Elsevier, vol. 16(4), pages 494-506, August.
    6. Daniel W. Elfenbein & Anne Marie Knott, 2015. "Time to exit: Rational, behavioral, and organizational delays," Strategic Management Journal, Wiley Blackwell, vol. 36(7), pages 957-975, July.
    7. Shepherd, Dean A. & Wiklund, Johan & Haynie, J. Michael, 2009. "Moving forward: Balancing the financial and emotional costs of business failure," Journal of Business Venturing, Elsevier, vol. 24(2), pages 134-148, March.
    8. Rehnen, Lena Marie, 2016. "Exit strategies of loyalty programs," jbm - Journal of Business Market Management, Free University Berlin, Marketing Department, vol. 9(1), pages 564-596.
    9. Baboo M Nowbutsing, 2012. "Experiments in International Economics," Journal of Economics and Behavioral Studies, AMH International, vol. 4(2), pages 75-86.
    10. Turvey, Calum G., 2002. "Can Hysteresis And Real Options Explain The Farmland Valuation Puzzle?," Working Papers 34131, University of Guelph, Department of Food, Agricultural and Resource Economics.

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