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Switching Between Chartists and Fundamentalists: A Markov Regime-Switching Approach

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Author Info
Robert Vigfusson

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Abstract

Since the early 1980s, models based on economic fundamentals have been poor at explaining the movements in the exchange rate (Messe 1990). In response to this problem, Frankel and Froot (1988) developed a model that uses two approaches to forecast the exchange rate: the fundamentalist approach, which bases the forecast on economic fundamentals, and the chartist approach, which bases the forecast on the past behaviour of the exchange rate. This was an innovation, as only the fundamentalist approach had been used before. A feature of the chartist-and-fundamentalist (c&f) model is that these two approaches' relative importance varies over time. Because this weighting is unobserved, the c&f model can not be estimated or tested using standard techniques. To overcome these difficulties and to test the model, the author uses Markov regime-switching techniques. He defines the two groups' different methods of forecasting as regimes and rewrites the c&f model as a regime-switching model. The model is then used to test for c&f behaviour in the Canada-U.S. daily exchange rate between 1983 and 1992. The author finds favourable though inconclusive evidence for the c&f model and accordingly makes suggestions for further research.

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Paper provided by EconWPA in its series International Finance with number 9602003.

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Length: 22 pages
Date of creation: 19 Feb 1996
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Handle: RePEc:wpa:wuwpif:9602003

Note: 22 printed pages, compressed PostScript file. Other recent Bank of Canada working papers are listed on the last page of this report.
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Find related papers by JEL classification:
F3 - International Economics - - International Finance
F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

References listed on IDEAS
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  1. Cutler, David M & Poterba, James M & Summers, Lawrence H, 1990. "Speculative Dynamics and the Role of Feedback Traders," American Economic Review, American Economic Association, vol. 80(2), pages 63-68, May. [Downloadable!] (restricted)
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  2. Alain DeSerres & Alain Guay & Pierre St-Amant, 1995. "Estimating and Projecting Potential Output Using Structural VAR Methodology," Macroeconomics 9504003, EconWPA. [Downloadable!]
  3. Robert A. Amano & Tony S. Wirjanto, . "An Empirical Investigation into Government Spending and Private Sector Behaviour," Working Papers 94-8, Bank of Canada. [Downloadable!]
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  4. Brock, W. & Lakonishok, J. & Lebaron, B., 1991. "Simple Technical Trading Rules And The Stochastic Properties Of Stock Returns," Working papers 90-22, Wisconsin Madison - Social Systems.
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Gunduz Caginalp & Vladimira Ilieva, 2006. "The dynamics of trader motivations in asset bubbles," Labsi Experimental Economics Laboratory University of Siena 008, University of Siena. [Downloadable!]
  2. Stefan Reitz, 2005. "Central Bank Intervention and Heterogeneous Exchange Rate Expectations: Evidence from the Daily DEM/US-Dollar Exchange Rate," Open Economies Review, Springer, vol. 16(1), pages 33-50, January. [Downloadable!] (restricted)
  3. John Barkoulas & Christopher F. Baum & Mustafa Caglayan, 1998. "Exchange Rate Effects on the Volume and Variability of Trade Flows," Boston College Working Papers in Economics 405., Boston College Department of Economics, revised 12 Sep 2001. [Downloadable!]
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  4. Isabelle Weberpals, 1997. "The Liquidity Trap: Evidence from Japan," Working Papers 97-4, Bank of Canada. [Downloadable!]
  5. Oreste Napolitano, 2006. "Is the Impact of ECB Monetary Policy on EMU Stock Market Returns asymmetric?," Discussion Papers 1_2006, D.E.S. (Department of Economic Studies), University of Naples "Parthenope", Italy. [Downloadable!]
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  6. Christian Bauer & Paul De Grauwe & Stefan Reitz, 2007. "Exchange Rates Dynamics in a Target Zone – A Heterogeneous Expectations Approach," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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  7. Ralf Ahrens & Stefan Reitz, 2000. "Chartist Prediction in the Foreign Exchange Market. Evidence from the Daily Dollar/DM Exchange Rate," Econometric Society World Congress 2000 Contributed Papers 1683, Econometric Society. [Downloadable!]
  8. Murray, John & Mark Zelmer & Zahir Antia, 2000. "International Financial Crises and Flexible Exchange Rates: Some Policy Lessons from Canada," Technical Reports 88, Bank of Canada. [Downloadable!]
  9. Christopher F. Baum & Mustafa Caglayan & John T. Barkoulas, 1999. "Exchange Rate Uncertainty and Firm Profitability," Boston College Working Papers in Economics 422, Boston College Department of Economics, revised 16 Feb 2000. [Downloadable!]
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  10. Simone Alfarano & Thomas Lux & Friedrich Wagner, 2005. "Estimation of Agent-Based Models: The Case of an Asymmetric Herding Model," Computational Economics, Springer, vol. 26(1), pages 19-49, August. [Downloadable!] (restricted)
  11. Reitz, Stefan, 2002. "Central Bank Intervention and Exchange Rate Expectations: Evidence from the Daily DM/US-Dollar Exchange Rate," Discussion Paper Series 1: Economic Studies 2002,17, Deutsche Bundesbank, Research Centre. [Downloadable!]
  12. Menkhoff, Lukas & Taylor, Mark P., 2006. "The Obstinate Passion of Foreign Exchange Professionals : Technical Analysis," The Warwick Economics Research Paper Series (TWERPS) 769, University of Warwick, Department of Economics. [Downloadable!]
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  13. Murray, J. & Van Norden, S. & Vigfusson, R., 1996. "Excess Volatility and Speculative Bubbles in the Canadian Dollar: Real of Imagined?," Technical Reports 76, Bank of Canada. [Downloadable!]
  14. Ralf Ahrens & Stefan Reitz, 2003. "Heterogeneous Expectations in the Foreign Exchange Market Evidence from the Daily Dollar/DM Exchange Rate," CFS Working Paper Series 2003/11, Center for Financial Studies. [Downloadable!]
  15. Laurence Lasselle & Serge Svizzero & Clem Tisdell, 2001. "Heterogeneous Beliefs and Instability," Discussion Paper Series, Department of Economics 0111, Department of Economics, University of St. Andrews. [Downloadable!]
  16. Michel Beine & Paul De Grauwe & Marianna Grimaldi, 2005. "The Impact of FX Central Bank Intervention in a Noise Trading Framework," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
  17. Gehrig, Thomas & Menkhoff, Lukas, 2003. "Technical Analysis in Foreign Exchange - The Workhorse Gains Further Ground," Diskussionspapiere der Wirtschaftswissenschaftlichen Fakultät der Universität Hannover dp-278, Universität Hannover, Wirtschaftswissenschaftliche Fakultät. [Downloadable!]
  18. Zwart, G.J. de & Markwat, T.D. & Swinkels, L. & Dijk, D.J.C. van, 2007. "The Economic Value of Fundamental and Technical Information in Emerging Currency Markets," Research Paper ERS-2007-096-F&A Revision, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus Uni. [Downloadable!]
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  19. Taylor, Mark P, 2003. "Is Official Exchange Rate Intervention Effective?," CEPR Discussion Papers 3758, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  20. Roberta Colavecchio & Michael Funke, 2007. "Volatility dependence across Asia-Pacific on-shore and off-shore U.S. dollar futures markets," Quantitative Macroeconomics Working Papers 20708, Hamburg University, Department of Economics. [Downloadable!]
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