Switching Between Chartists and Fundamentalists: A Markov Regime-Switching Approach
AbstractSince 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 that uses two approaches to forecast the exchange rate: the fundamentalist approach, which bases the forecast on economic fundamentals, and the chartist approach, which bases the forecast on the past behaviour of the exchange rate. This was an innovation, as only the fundamentalist approach had been used before. A feature of the chartist-and-fundamentalist (c&f) model is that these two approaches' relative importance varies over time. Because this weighting is unobserved, the c&f model can not be estimated or tested using standard techniques. To overcome these difficulties and to test the model, the author uses Markov regime-switching techniques. He defines the two groups' different methods of forecasting as regimes and rewrites the c&f model as a regime-switching model. The model is then used to test for c&f behaviour in the Canada-U.S. daily exchange rate between 1983 and 1992. The author finds favourable though inconclusive evidence for the c&f model and accordingly makes suggestions for further research.
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Bibliographic InfoPaper provided by Bank of Canada in its series Working Papers with number 96-1.
Length: 31 pages
Date of creation: 1996
Date of revision:
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Other versions of this item:
- Vigfusson, Robert, 1997. "Switching between Chartists and Fundamentalists: A Markov Regime-Switching Approach," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 2(4), pages 291-305, October.
- Robert Vigfusson, 1996. "Switching Between Chartists and Fundamentalists: A Markov Regime-Switching Approach," International Finance 9602003, EconWPA.
- C40 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - General
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
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