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Currency Market Participants' Mental Model and the Collapse of the Dollar: 2001-2008

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  • John T. Harvey

Abstract

It is well accepted among Institutionalist and Post Keynesian scholars that portfolio investment markets are driven by agents' expectations rather than "the fundamentals." This explains, it is argued, why asset and currency prices are so much more volatile than and often clearly out of line with what we would otherwise consider to be their underlying determinants. What is rarely addressed, however, is how those expectations are formed. This paper fills the void by proposing a specific view of agents' expectations based on the mental model they employ to understand currency movements. The paper derives this schematic by examining market participants' psychological propensities and the world view of the subculture of which they are members. It will be shown that the model is consistent with the salient features of the foreign exchange market and it is employed to explain the dollar's fall from 2001 through 2008.

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Bibliographic Info

Article provided by M.E. Sharpe, Inc. in its journal Journal of Economic Issues.

Volume (Year): 43 (2009)
Issue (Month): 4 (December)
Pages: 931-949

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Handle: RePEc:mes:jeciss:v:43:y:2009:i:4:p:931-949

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Web page: http://www.mesharpe.com/mall/results1.asp?acr=jei

Related research

Keywords: mental model; psychology; exchange rates; foreign currency;

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References

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  1. John T. Harvey, 1993. "Daily Exchange Rate Variance," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 15(4), pages 515-540, July.
  2. Yin-Wong Cheung & Menzie D. Chinn & Ian W. Marsh, 2000. "How Do UK-Based Foreign Exchange Dealers Think Their Market Operates?," NBER Working Papers 7524, National Bureau of Economic Research, Inc.
  3. Ederington, Louis H & Lee, Jae Ha, 1993. " How Markets Process Information: News Releases and Volatility," Journal of Finance, American Finance Association, vol. 48(4), pages 1161-91, September.
  4. John T. Harvey, 2004. "Deviations from uncovered interest rate parity: a Post Keynesian explanation," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 27(1), pages 19-35, October.
  5. Imad A. Moosa, 2007. "Neoclassical versus Post Keynesian models of exchange rate determination: a comparison based on nonnested model selection tests and predictive accuracy," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 30(2), pages 169-185, December.
  6. Hiroya Akiba, 2004. "Expectations, stability, and exchange rate dynamics under the Post Keynesian hypothesis," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 27(1), pages 125-140, October.
  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. John Harvey, 2001. "The Determinants of Currency Market Forecasts: An Empirical Study," Working Papers 200102, Texas Christian University, Department of Economics.
  9. Imad A. Moosa, 2002. "A Test of the Post Keynesian Hypothesis on Expectation Formation in the Foreign Exchange Market," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 24(3), pages 443-457, April.
  10. Imad A. Moosa, 2004. "An empirical examination of the Post Keynesian view of forward exchange rates," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 26(3), pages 395-418, April.
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