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Heterogeneous Expectations in the Foreign Exchange Market Evidence from the Daily Dollar/DM Exchange Rate

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Author Info
Ralf Ahrens (DGZ DEKABANK, Financial Engineering & Consulting,)
Stefan Reitz () (University of Giessen)

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Abstract

In this study a regime switching approach is applied to estimate the chartist and fundamentalist (c&f) exchange rate model originally proposed by Frankel and Froot (1986). The c&f model is tested against alternative regime switching specifications applying likelihood ratio tests. Nested atheoretical models like the popular segmented trends model suggested by Engel and Hamilton (1990) are rejected in favour of the multi agent model. Moreover, the c&f regime switching model seems to describe the data much better than a competing regime switching GARCH(1,1) model. Finally, our findings turned out to be relatively robust when estimating the model in subsamples. The empirical results suggest that the model is able to explain daily DM/Dollar forward exchange rate dynamics from 1982 to 1998.

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Paper provided by Center for Financial Studies in its series CFS Working Paper Series with number 2003/11.

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Length: 19 pages
Date of creation: 11 Jan 2003
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Handle: RePEc:cfs:cfswop:wp200311

Note: Corresponding author: Stefan Reitz, Department of Economics, University of Giessen, Licher Strasse 66, 35394 Giessen, Germany, phone: ++49 (641) 9922114, fax: ++49 (641) 9922119, Email: stefan.reitz@wirtschaft.uni-giessen.de; Ralf Ahrens, DGZ DEKABANK, Financial Engineering & Consulting, Mainzer Landstrasse 50, 60329 Frankfurt am Main, Germany. We thank the seminar participants at the Econometric Society Eighth World Congress and an anonymous referee for very helpful comments on earlier drafts of this paper.
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Related research
Keywords: exchange rates; multi agent models; regime-switching;

Find related papers by JEL classification:
F31 - International Economics - - International Finance - - - Foreign Exchange
C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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