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Switching between Chartists and Fundamentalists: A Markov Regime-Switching Approach

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  • Vigfusson, Robert

Abstract

Since the early 1980s, models based on economic fundamentals have been poor at explaining the movements in the exchange rate (Messe, 1990). In response to this problem, Frankel and Froot (1988) developed a model where two approaches are used to forecast the exchange rate. The fundamentalist approach, where the forecast is based upon economic fundamentals, continues to be used. This models innovation is that the chartist approach, where the forecast is based upon the past behaviour of the exchange rate, is also used. A feature of this chartist-and-fundamentalist (c&f) model is that these two approaches relative importance varies over time. As this weighting is unobserved, the c&f model cannot be estimated or tested using standard techniques. We purpose to use Markov regime-switching techniques to overcome these difficulties and test the model. By defining the two groups different methods of forecasting as regimes, we rewrite the c&f model as a regime-switching model. This approach is used here to test for chartist and fundamentalist behaviour in the Canada-US daily exchange rate between 1983 and 1992. We find favourable though inconclusive evidence for the c&f model. Accordingly, we make suggestions for further research. Copyright @ 1997 by John Wiley & Sons, Ltd. All rights reserved.

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

Volume (Year): 2 (1997)
Issue (Month): 4 (October)
Pages: 291-305

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Handle: RePEc:ijf:ijfiec:v:2:y:1997:i:4:p:291-305

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  1. Culter, D.M. & Poterba, J.M. & Summers, L.H., 1990. "Speculative Dynamics And The Role Of Feedback Traders," Working papers 545, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. Robert A. Amano & Tony S. Wirjanto, . "An Empirical Investigation into Government Spending and Private Sector Behaviour," Working Papers 94-8, Bank of Canada.
  3. Alain DeSerres & Alain Guay & Pierre St-Amant, 1995. "Estimating and Projecting Potential Output Using Structural VAR Methodology," Macroeconomics 9504003, EconWPA.
  4. Charles Engel, 1992. "Can the Markov Switching Model Forecast Exchange Rates?," NBER Working Papers 4210, National Bureau of Economic Research, Inc.
  5. Brock, William & Lakonishok, Josef & LeBaron, Blake, 1992. " Simple Technical Trading Rules and the Stochastic Properties of Stock Returns," Journal of Finance, American Finance Association, vol. 47(5), pages 1731-64, December.
  6. Amano, Robert A. & van Norden, Simon, 1995. "Terms of trade and real exchange rates: the Canadian evidence," Journal of International Money and Finance, Elsevier, vol. 14(1), pages 83-104, February.
  7. Taylor, Mark P. & Allen, Helen, 1992. "The use of technical analysis in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 11(3), pages 304-314, June.
  8. Hansen, Bruce E, 1992. "The Likelihood Ratio Test under Nonstandard Conditions: Testing the Markov Switching Model of GNP," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 7(S), pages S61-82, Suppl. De.
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