Behavioral Models of the Foreign Exchange Market: is there any empirical content?

João Barroso

No 364, Working Papers Series from Central Bank of Brazil, Research Department

Abstract: Behavioral models of the foreign exchange market explore the bias of economic agents towards forecasting rules with good recent performance. We propose an empirical framework to study such models without imposing restrictions on the set of forecasting rules or performance metrics. In particular, we propose a significance test for the constraints imposed by behavioral models relative to a very general non parametric alternative based on neural networks. We apply the framework to a unique dataset for the Brazilian foreign exchange market with full records of net order flow intermediated by the financial system, therefore connecting behavioral models to market microstructure models. The results support tightening constraints by 96% in the direction of behavioral models and this result is robust to assumptions regarding private order flow information.

Date: 2014-09
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