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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

Author

Listed:
  • David Ansic

    (University of Leeds)

  • Geoffrey Pugh

    (Staffordshire University)

Abstract

In the 1980's, 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 computerised experiment in which 100 subjects generated over 1,000 decisions on market entry and exit under conditions congruent with a model of trade hysteresis developed by Paul Krugman. Secondly, this data is 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.

Suggested Citation

  • David Ansic & Geoffrey Pugh, "undated". "An experimental test of trade hysteresis: market exit and entry decisions in the presence of sunk costs and exchange rate uncertainty," Working Papers 002, Staffordshire University, Business School.
    • Handle: RePEc:wuk:stafwp:002
    as

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    References listed on IDEAS

    as
    1. Smith, Vernon L, 1982. "Microeconomic Systems as an Experimental Science," American Economic Review, American Economic Association, vol. 72(5), pages 923-955, December.
    2. Ansic, David & Keasey, Kevin, 1994. "Repeated decisions and attitudes to risk," Economics Letters, Elsevier, vol. 45(2), pages 185-189, June.
    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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    More about this item

    Keywords

    Exchange rate instability; decision making under uncertainty; trade hysteresis;
    All these keywords.

    JEL classification:

    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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