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Chartist Prediction in the Foreign Exchange Market. Evidence from the Daily Dollar/DM Exchange Rate

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Ralf Ahrens (Center for Financial Studies)
Stefan Reitz (Justus-Liebig-University 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 empirical results suggest that this model does successfully explain daily DM/Dollar forward exchange rate dynamics from 1982 to 1998. Moreover, our findings turned out to be relative robust by estimating the model in subsamples. A particular focus of this study is on testing the c&f model against alternative regime switching specifications applying likelihood ratio tests. The results are striking. Nested atheoretical models like the popular segmented trends model suggested by Engel and Hamilton (1990) are rejected in favour of the c&f model. Finally, the c&f regime switching model seems to describe the data much better than a competing regime switching GARCH(1,1) model.

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Paper provided by Econometric Society in its series Econometric Society World Congress 2000 Contributed Papers with number 1683.

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Date of creation: 01 Aug 2000
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Handle: RePEc:ecm:wc2000:1683

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  1. Engel, Charles & Hamilton, James D, 1990. "Long Swings in the Dollar: Are They in the Data and Do Markets Know It?," American Economic Review, American Economic Association, vol. 80(4), pages 689-713, September. [Downloadable!] (restricted)
  2. Robert P. Flood & Andrew K. Rose, 1993. "Fixing Exchange Rates: A Virtual Quest for Fundamentals," NBER Working Papers 4503, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 703-38, August. [Downloadable!] (restricted)
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  4. Mark P. Taylor, 1995. "The Economics of Exchange Rates," Journal of Economic Literature, American Economic Association, vol. 33(1), pages 13-47, March. [Downloadable!] (restricted)
  5. Diebold, Francis X. & Nason, James A., 1990. "Nonparametric exchange rate prediction?," Journal of International Economics, Elsevier, vol. 28(3-4), pages 315-332, May. [Downloadable!] (restricted)
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  6. Frankel, Jeffrey A & Froot, Kenneth A, 1986. "Understanding the U.S. Dollar in the Eighties: The Expectations of Chartists and Fundamentalists," The Economic Record, The Economic Society of Australia, vol. 0(0), pages 24-38, Supplemen.
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  7. Hans Dewachter, 1997. "Sign predictions of exchange rate changes: Charts as proxies for Bayesian inferences," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 133(1), pages 39-55, March. [Downloadable!] (restricted)
  8. 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. [Downloadable!] (restricted)
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