An attempt is made to identify the expectation formation mechanism dominating the foreign exchange market and to demonstrate that exchange rate volatility can be attributed to the heterogeneity of traders with respect to expectation formation. The criterion used to identify the dominance of a particular mechanism is the profitability of trading based on that mechanism. It is concluded that mixed and extrapolative expectations are the dominant mechanisms, that market participants follow some sort of a herd behaviour, and that they pay attention to the expectations of other participants. It is also found that the heterogeneity of market participants with respect to expectation formation goes a long way towards explaining volatility.
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Article provided by Taylor and Francis Journals in its journal Applied Economics.
Volume (Year): 36 (2004) Issue (Month): 14 (August) Pages: 1599-1606 Download reference. The following formats are available: HTML
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