Expectations Driven Distortions in the Foreign Exchange Market

Frank Westerhoff

No 48, Computing in Economics and Finance 2001 from Society for Computational Economics

Abstract: This paper explores the phenomenon of lasting deviations of the exchange rate from its fundamental value in the foreign exchange market. Motivated by empirical observations a chartists-fundamentalists model is developed in which boundedly rational agents repeatedly choose between technical and fundamental trading rules to determine their speculative investment positions. Crucial for the dynamics is how the traders perceive the fundamental exchange rate. This perception process is based on psychological evidence. Simulations give rise to bubbles but simultaneously display quite realistic exchange rate dynamics (unit roots in the exchange rates, fat tails for returns, and volatility clustering).

Keywords: exchange rate theory; technical and fundamental trading rules; expectations and learning; market efficiency (search for similar items in EconPapers)
JEL-codes: F31 G14 (search for similar items in EconPapers)
Date: 2001-04-01
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Related works:
Journal Article: Expectations driven distortions in the foreign exchange market (2003)
Working Paper: Expectations Driven Distortions in the Foreign Exchange Market (2001)
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