The New Palgrave Dictionary of Economics

2018 Edition
| Editors: Macmillan Publishers Ltd

Peso Problem

  • Karen K. Lewis
Reference work entry
DOI: https://doi.org/10.1057/978-1-349-95189-5_2504

Abstract

If market participants expect a future discrete change in asset fundamentals, then rational forecast errors may be correlated with current information and have a mean different from zero in finite samples. This statement may seem inconsistent with the standard assumption that forecast errors are orthogonal to current information and have a mean of zero. By contrast, this article describes how this phenomenon may be rational using the example of the Mexican peso market in which it was first noted. It then illustrates how the peso problem applies more generally to a wide range of asset prices.

Keywords

Efficient markets hypothesis Foreign exchange risk premium Friedman, M. German hyperinflation Learning Martingales Peso problem Rational expectations Regimeswitching models Risk neutrality Stock price volatility Term premium White noise 
This is a preview of subscription content, log in to check access

Bibliography

  1. Ang, A., L. Gu, and Y. Hochberg. 2007. Is IPO underperformance a peso problem? Journal of Financial and Quantitative Analysis 42: 565–594.CrossRefGoogle Scholar
  2. Barro, R. 2006. Rare disasters and asset markets in the 20th century. Quarterly Journal of Economics 121: 823–866.CrossRefGoogle Scholar
  3. Bates, D.S. 1991. The Crash of 87: was it expected? The evidence from options markets. Journal of Finance 46: 1009–1044.CrossRefGoogle Scholar
  4. Bekaert, G., R.J. Hodrick, and D.A. Marshall. 2001. Peso problem explanations for term structure anomalies. Journal of Monetary Economics 48: 241–270.CrossRefGoogle Scholar
  5. Bertola, G., and L.E.O. Svensson. 1993. Stochastic devaluation risk and the empirical fit of target-zone models. Review of Economic Studies 60: 689–712.CrossRefGoogle Scholar
  6. Campa, J.M., and P.H.K. Chang. 1996. Arbitrage-based tests of target-zone credibility: Evidence from ERM cross-rate options. American Economic Review 86: 726–740.Google Scholar
  7. Campa, J.M., P.H.K. Chang, and J.F. Refalo. 2002. An options-based analysis of emerging market exchange rate expectations: Brazil’s real plan, 1994–1999. Journal of Development Economics 69: 227–253.CrossRefGoogle Scholar
  8. Cecchetti, S.G., P. Lam, and N.C. Mark. 1993. The equity premium and the risk-free rate: Matching the moments. Journal of Monetary Economics 31: 21–45.CrossRefGoogle Scholar
  9. Engel, C., and J.D. Hamilton. 1990. Long swings in the dollar: Are they in the data and do markets know it? American Economic Review 80: 689–713.Google Scholar
  10. Evans, M.D.D., and K.K. Lewis. 1995a. Do expected shifts in inflation affect estimates of the long-run Fisher relation? Journal of Finance 50: 225–253.CrossRefGoogle Scholar
  11. Evans, M.D.D., and K.K. Lewis. 1995b. Do long-term swings in the dollar affect estimates of the risk premia? Review of Financial Studies 8: 709–742.CrossRefGoogle Scholar
  12. Flood, R., and P. Garber. 1980. An economic theory of monetary reform. Journal of Political Economy 88: 24–58.CrossRefGoogle Scholar
  13. Hallwood, C.P., R. MacDonald, and I.W. Marsh. 2000. Realignment expectations and the US dollar, 1890–1897: was there a ‘Peso Problem’? Journal of Monetary Economics 46: 605–620.CrossRefGoogle Scholar
  14. Kaminsky, G. 1993. Is there a peso problem? Evidence from the dollar/pound exchange rate: 1976–1987. American Economic Review 83: 450–472.Google Scholar
  15. Krasker, W.S. 1980. The peso problem in testing the efficiency of forward exchange markets. Journal of Monetary Economics 6: 269–276.CrossRefGoogle Scholar
  16. Lewis, K.K. 1989. Changing beliefs and systematic forecast errors. American Economic Review 79: 621–636.Google Scholar
  17. Lewis, K.K. 1991. Was there a peso problem in the U.S. interest rate term structure: 1979–1982. International Economic Review 32: 159–173.CrossRefGoogle Scholar
  18. Lizondo, J.S. 1983. The efficiency of the Mexican peso market. Journal of International Economics 14: 69–84.CrossRefGoogle Scholar
  19. Mundaca, G. 2004. Modeling probabilities of devaluations. Economica 71: 13–37.CrossRefGoogle Scholar
  20. Rietz, T.A. 1988. The equity risk premium: A solution. Journal of Monetary Economics 22: 117–131.CrossRefGoogle Scholar
  21. Rogoff, K. 1977. Rational expectations in the foreign exchange market revisited. Massachusetts Institute of Technology. Unpublished manuscript.Google Scholar
  22. Rogoff, K. 1980. Tests of the martingale model for foreign exchange futures markets. In Essays on expectations and exchange rate volatility. Ph.D. dissertation, Massachusetts Institute of Technology.Google Scholar
  23. Salant, S., and D. Henderson. 1978. Market anticipations of government policies and the price of gold. Journal of Political Economy 86: 627–648.CrossRefGoogle Scholar
  24. Timmermann, A.G. 1993. How learning in financial markets generates excess volatility and predictability in stock prices. Quarterly Journal of Economics 108: 1135–1145.CrossRefGoogle Scholar

Copyright information

© Macmillan Publishers Ltd. 2018

Authors and Affiliations

  • Karen K. Lewis
    • 1
  1. 1.