Dynamic Forecasting Rules and the Complexity of Exchange Rate Dynamics
AbstractThis paper investigates the exchange rate dynamics implied by a heterogeneous agent model proposed in De Grauwe and Grimaldi (2006). The two groups of agents, chartists and fundamentalists, use simple forecasting rules and the ex post relative profitability to decide whether to switch to the other group. We extend this model by introducing a simple evolutionary selection mechanism which allows agents not only to switch between groups but also to adapt the forecasting rule of each group over time. Two results stand out: (i) This selection process naturally leads agents to choose forecasting rules over time which results in the convergence of the exchange rate to its fundamental value; and (ii) The learning rule is not robust to the introduction of shocks to the fundamental. Once we allow for random variation in the fundamental, the model exhibits again all of the nonlinear features discussed in De Grauwe and Grimaldi (2006): the disconnect puzzle, volatility clustering and fat tails.
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Bibliographic InfoPaper provided by Insper Working Paper, Insper Instituto de Ensino e Pesquisa in its series Insper Working Papers with number wpe_260.
Date of creation: Oct 2011
Date of revision:
Other versions of this item:
- H. Dewachter & R. Houssa & M. Lyrio & P.R. Kaltwasser, 2011. "Dynamic Forecasting Rules and the Complexity of Exchange Rate Dynamics," Review of Business and Economic Literature, Intersentia, vol. 56(4), pages 454-472, December.
- NEP-ALL-2011-12-19 (All new papers)
- NEP-FOR-2011-12-19 (Forecasting)
- NEP-MON-2011-12-19 (Monetary Economics)
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