Animal spirits in the foreign exchange market

Paul De Grauwe and Pablo Rovira Kaltwasser

Journal of Economic Dynamics and Control, 2012, vol. 36, issue 8, 1176-1192

Abstract: It is traditionally assumed in finance models that the fundamental value of an asset is known with certainty. In this paper we depart from that assumption. We propose a simple model of the exchange rate in which agents have biased and unbiased beliefs about the fundamental rate. We show that such a model produces waves of optimism and pessimism unrelated to the underlying fundamental value. In addition, the model shows that in a world characterized by the existence of heterogeneous beliefs about the fundamental, exchange rate movements can be remarkably complex even if only fundamentalist traders operate in the market.

Keywords: Foreign exchange market; Behavioral finance; Uncertainty about fundamentals (search for similar items in EconPapers)
JEL-codes: C62 F31 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (35)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:36:y:2012:i:8:p:1176-1192

DOI: 10.1016/j.jedc.2012.03.008

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