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Exchange Rate Puzzles: A Tale of Switching Attractors

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  • De Grauwe, Paul

    ()
    (University of Leuven)

  • Grimaldi, Marianna

    ()
    (Research Department, Central Bank of Sweden)

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    Abstract

    The rational expectations efficient market model of the exchange rate has failed empirically. In this paper we develop a model of the exchange rate in which agents use simple forecasting rules. Based on an ex post evaluation of the relative profitability of these rules they decide whether to switch or not. In addition, transactions costs in the goods market are introduced. We show that this simple model creates great complexity in the market which is characterised by the fact that the exchange rate is disconnected from its fundamental most of the time. Finally we show that this model mimicks most of the empirical puzzles uncovered in the literature.

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    File URL: http://www.riksbank.se/upload/WorkingPapers/WP_163.pdf
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    Bibliographic Info

    Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 163.

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    Length: 42 pages
    Date of creation: 01 May 2004
    Date of revision:
    Publication status: Published in European Economic Review, 2006, pages 1-33.
    Handle: RePEc:hhs:rbnkwp:0163

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    Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
    Phone: 08 - 787 00 00
    Fax: 08-21 05 31
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    Keywords: Exchange rate; Heterogeneous agents; Technical trading; Transaction costs;

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    References

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    1. Alan P. Kirman, Gilles Teyssiere, 2001. "Microeconomic Models for Long-Memory in the Volatility of Financial Time Series," Computing in Economics and Finance 2001 221, Society for Computational Economics.
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    Cited by:
    1. Vansteenkiste, Isabel, 2011. "What is driving oil futures prices? Fundamentals versus speculation," Working Paper Series 1371, European Central Bank.
    2. Gaunersdorfer, A. & Hommes, C.H., 2005. "A nonlinear structural model for volatility clustering," CeNDEF Working Papers 05-02, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
    3. Hannes Haushofer & Gabriel Moser & Renate Unger, 2005. "Fundamental and Nonfundamental Factors in the Euro/U.S. Dollar Market in 2002 and 2003," Monetary Policy & the Economy, Oesterreichische Nationalbank (Austrian Central Bank), issue 1, pages 58–76.

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