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Heterogeneous expectations and exchange rate dynamics

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  • Carl Chiarella
  • Xue-Zhong He
  • Min Zheng

Abstract

This article presents a continuous-time model of exchange rates not only relying on macroeconomic factors but also having an investor heterogeneity component. The driving macroeconomic factor is the domestic--foreign interest rate differential, while the investor heterogeneity is described by the expectations of boundedly rational portfolio managers who use a weighted average of the expectations of fundamentalists and chartists. Within this framework, the different roles of the macroeconomic factor and investor heterogeneity in the determination of the exchange rate are examined explicitly. We show that this simple model generates very complicated market behaviour, including the existence of multiple steady-state equilibria, deviations of the market exchange rate from the fundamental one and market fluctuations. Numerical simulation of the corresponding stochastic version of the model shows that the model is able to generate typical time series and volatility clustering patterns observed in exchange rate markets.

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File URL: http://hdl.handle.net/10.1080/1351847X.2011.601690
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Bibliographic Info

Article provided by Taylor & Francis Journals in its journal The European Journal of Finance.

Volume (Year): 19 (2013)
Issue (Month): 5 (May)
Pages: 392-419

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Handle: RePEc:taf:eurjfi:v:19:y:2013:i:5:p:392-419

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  14. Takatoshi Ito, 1988. "Foreign Exchange Rate Expectations: Micro Survey Data," NBER Working Papers 2679, National Bureau of Economic Research, Inc.
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  16. Carl Chiarella & Roberto Dieci & Xue-Zhong He, 2008. "Heterogeneity, Market Mechanisms, and Asset Price Dynamics," Research Paper Series 231, Quantitative Finance Research Centre, University of Technology, Sydney.
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Cited by:
  1. Peter Flaschel & Florian Hartmann & Chris Malikane & Christian R. Proaño, 2014. "A Behavioral Macroeconomic Model of Exchange Rate Fluctuations with Complex Market Expectations Formation," Working Papers 98, Institute of Empirical Economic Research, revised 29 Jan 2014.
  2. Wilson Sy, 2009. "Towards a national default option for low-cost superannuation," Accounting Research Journal, Emerald Group Publishing, vol. 22(1), pages .46-67, July.

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