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.
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Lewis, K.K. (2018). Peso Problem. In: The New Palgrave Dictionary of Economics. Palgrave Macmillan, London. https://doi.org/10.1057/978-1-349-95189-5_2504
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DOI: https://doi.org/10.1057/978-1-349-95189-5_2504
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