Model Misspecification, Learning and the Exchange Rate Disconnect Puzzle

Vivien Lewis () and Agnieszka Markiewicz ()

Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium from Ghent University, Faculty of Economics and Business Administration

Abstract: Rational expectations models fail to explain the disconnect between the ex-change rate and macroeconomic fundamentals. In line with survey evidence on the behaviour of foreign exchange traders, we introduce model misspecification and learning into a standard monetary model. Agents use simple forecasting rules based on a restricted information set. They learn about the parameters and performance of different models and can switch between forecasting rules. We compute the implied US-UK post-Bretton Woods exchange rate under learning. While the excess volatility of the exchange rate return can be reproduced with low values of the learning gain, the implied correlations with the fundamentals are higher than in the data.

Keywords: exchange rate; disconnect; misspecification; learning (search for similar items in EconPapers)
JEL-codes: F31 E37 E44 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-ifn and nep-mst
Date: 2009-03
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Related works:
Working Paper: Model misspecification, learning and the exchange rate disconnect puzzle (2009)
Journal Article: Model Misspecification, Learning and the Exchange Rate Disconnect Puzzle (2009)
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Persistent link: http://EconPapers.repec.org/RePEc:rug:rugwps:09/563

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