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The Exchange Rate and its Fundamentals. A Chaotic Perspective

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  • Paul De Grauwe
  • Marianna Grimaldi
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    Abstract

    We analyse the workings of a simple non-linear exchange rate model in which agents hold different beliefs about the underlying model. We distinguish between ‘chartists’ and ‘fundamentalists’. The non-linearities in the model originate from transactions costs and from the existence of non-linear adjustment dynamics in the goods market. We find, first, that the simple non-linear structure of the model is capable of generating a very complex exchange rate dynamics. Second, our model is capable of explaining some empirical puzzles concerning exchange rate behaviour, i.e. the ‘disconnect’ puzzle which says that the exchange rate is disconnected form its underlying fundamentals most of the time and the excess volatility puzzle.

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    File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2002/wp-cesifo-2002-01/639.PDF
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    Bibliographic Info

    Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 639.

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    Date of creation: 2002
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    Handle: RePEc:ces:ceswps:_639

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    1. Paul Hallwood & Ronald MacDonald, 2008. "International Money and Finance," Working papers, University of Connecticut, Department of Economics 2008-02, University of Connecticut, Department of Economics.
    2. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, Elsevier, vol. 14(1-2), pages 3-24, February.
    3. Maurice Obstfeld & Kenneth Rogoff & Ben Bernanke & Kenneth Rogoff, . "The Six Major Puzzles in International Macroeconomics: Is there a Common Cause?," Working Paper 32326, Harvard University OpenScholar.
    4. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
    5. Peel, David & Sarno, Lucio & Taylor, Mark P, 2001. "Nonlinear Mean-Reversion in Real Exchange Rates: Towards a Solution to the Purchasing Power Parity Puzzles," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2658, C.E.P.R. Discussion Papers.
    6. Lutz Kilian & Mark P. Taylor, 2001. "Why is it so difficult to beat the Random Walk Forecast of Exchange Rates?," Tinbergen Institute Discussion Papers 01-031/4, Tinbergen Institute.
    7. Marianne Baxter & Alan C. Stockman, 1988. "Business Cycles and the Exchange Rate System: Some International Evidence," NBER Working Papers 2689, National Bureau of Economic Research, Inc.
    8. Mark P. Taylor, 2003. "Purchasing Power Parity," Review of International Economics, Wiley Blackwell, vol. 11(3), pages 436-452, 08.
    9. Mordecai Kurz & Maurizio Motolese, 1999. "Endogenous Uncertainty and Market Volatility," Working Papers, Fondazione Eni Enrico Mattei 1999.27, Fondazione Eni Enrico Mattei.
    10. Taylor, Mark P. & Allen, Helen, 1992. "The use of technical analysis in the foreign exchange market," Journal of International Money and Finance, Elsevier, Elsevier, vol. 11(3), pages 304-314, June.
    11. Cheung, Yin-Wong & Lai, Kon S., 2000. "On the purchasing power parity puzzle," Journal of International Economics, Elsevier, Elsevier, vol. 52(2), pages 321-330, December.
    12. Li, Kai, 1999. "Testing Symmetry and Proportionality in PPP: A Panel-Data Approach," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 17(4), pages 409-18, October.
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    Cited by:
    1. Bauer, Christian & Herz, Bernhard, 2005. "Technical trading, monetary policy, and exchange rate regimes," Global Finance Journal, Elsevier, vol. 15(3), pages 281-302, February.
    2. repec:ebl:ecbull:v:3:y:2004:i:43:p:1-10 is not listed on IDEAS
    3. G. Dufrenot & E. Grimaud & E. Latil & V. Mignon, 2003. "Real exchange rate misalignment in Hungary: a fractionally integrated threshold model," THEMA Working Papers 2003-07, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
    4. Orlando Gomes, 2006. "Heterogeneous Researchers in a Two-Sector Representative Consumer Economy," Revista Brasileira de Economia, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil), vol. 60(2), pages 113-132, November.
    5. Gilles DUFRENOT & Elisabeth GRIMAUD & Eug=E9nie LATIL & Val=E9rie MIGNON, 2003. "Real exhange rate misalignment in Hungary: a fractionally integrated=20 threshold model," Econometrics, EconWPA 0309001, EconWPA.
    6. Christian Bauer & Bernhard Herz, 2006. "Monetary and Exchange Rate Stability at the EU. Mediterranean Borders," Revue économique, Presses de Sciences-Po, Presses de Sciences-Po, vol. 57(4), pages 899-917.
    7. Bauer, Christian & Herz, Bernhard, 2009. "Monetary and exchange rate stability in South and East Asia," Pacific-Basin Finance Journal, Elsevier, Elsevier, vol. 17(3), pages 352-371, June.

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