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Chartism and exchange rate volatility

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  • Mikael Bask

    (Monetary Policy and Research Department, Bank of Finland, Finland)

Abstract

The purpose of this paper is to implement theoretically, the observation that the relative importance of fundamental versus technical analysis in the foreign exchange market depends on the time horizon in currency trade. For shorter time horizons, more weight is placed on technical analysis, while more weight is placed on fundamental analysis for longer horizons. The theoretical framework is the Dornbusch overshooting model, where moving averages is the technical trading technique used by the chartists. The perfect foresight path near long-run equilibrium is derived, and it is shown that the magnitude of exchange rate overshooting is larger than in the Dornbusch model. Specifically, the extent of overshooting depends inversely on the time horizon in currency trade. How changes in the model's structural parameters endogenously affect this time horizon and the magnitude of overshooting along the perfect foresight path are also derived. Copyright © 2007 John Wiley & Sons, Ltd.

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File URL: http://hdl.handle.net/10.1002/ijfe.315
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Bibliographic Info

Article provided by John Wiley & Sons, Ltd. in its journal International Journal of Finance & Economics.

Volume (Year): 12 (2007)
Issue (Month): 3 ()
Pages: 301-316

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Handle: RePEc:ijf:ijfiec:v:12:y:2007:i:3:p:301-316

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  1. Flood, Robert P & Rose, Andrew K, 1999. "Understanding Exchange Rate Volatility without the Contrivance of Macroeconomics," Economic Journal, Royal Economic Society, vol. 109(459), pages F660-72, November.
  2. Dixon, Huw D, 1999. "Controversy: Exchange Rates and Fundamentals," Economic Journal, Royal Economic Society, vol. 109(459), pages F652-54, November.
  3. Lui, Yu-Hon & Mole, David, 1998. "The use of fundamental and technical analyses by foreign exchange dealers: Hong Kong evidence," Journal of International Money and Finance, Elsevier, vol. 17(3), pages 535-545, June.
  4. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
  5. Christopher J. Neely, 1997. "Technical analysis in the foreign exchange market: a layman's guide," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 23-38.
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Cited by:
  1. Bask, Mikael, 2007. "Instrument rules in monetary policy under heterogeneity in currency trade," Research Discussion Papers 22/2007, Bank of Finland.
  2. V. Lewis & A. Markiewicz, 2009. "Model Misspecification, Learning and the Exchange Rate Disconnect Puzzle," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 09/563, Ghent University, Faculty of Economics and Business Administration.
  3. Mikael Bask, 2009. "Announcement effects on exchange rates," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 14(1), pages 64-84.
  4. Mikael Bask, 2009. "Optimal monetary policy under heterogeneity in currency trade," Journal of Financial Economic Policy, Emerald Group Publishing, vol. 1(4), pages 338-354, May.
  5. Pippenger, John, 2008. "Freely Floating Exchange Rates Do Not Systematically Overshoot," University of California at Santa Barbara, Economics Working Paper Series qt97m8z6hw, Department of Economics, UC Santa Barbara.
  6. Mikael Bask & Jarko Fidrmuc, 2009. "Fundamentals and Technical Trading: Behavior of Exchange Rates in the CEECs," Open Economies Review, Springer, vol. 20(5), pages 589-605, November.
  7. Wan, Jer-Yuh & Kao, Chung-Wei, 2009. "Evidence on the contrarian trading in foreign exchange markets," Economic Modelling, Elsevier, vol. 26(6), pages 1420-1431, November.
  8. Bask, Mikael, 2007. "Long swings and chaos in the exchange rate in a DSGE model with a Taylor rule," Research Discussion Papers 19/2007, Bank of Finland.

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