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Exchange rate dynamics in a target zone: a heterogeneous expectations approach

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  • Bauer, Christian
  • De Grauwe, Paul
  • Reitz, Stefan

Abstract

We present a simple behavioral model with chartists and fundamentalists and analyze their trading behavior in a floating regime and in a target zone regime. Regarding the floating regime the model replicates the well-known stylized facts like excessive volatility, fat tails, volatility clustering and the exchange rate disconnect. When introducing a credible target zone the exchange rate remains for a considerably long period in the center of the band albeit the fundamental exchange rate does not exhibit mean reversion tendencies. The resulting hump-shaped distribution of the exchange rate greatly reduces the frequency of central bank intervention. The introduction of a target zone regime significantly reduces exchange rate volatility by decreasing speculative activity in the FX market. --

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Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 1: Economic Studies with number 2007,11.

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Date of creation: 2007
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Handle: RePEc:zbw:bubdp1:5864

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Keywords: Exchange rate; heterogeneous agents; target zones;

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Cited by:
  1. Reitz, Stefan & Rülke, Jan & Stadtmann, Georg, 2012. "Nonlinear Expectations in Speculative Markets," Annual Conference 2012 (Goettingen): New Approaches and Challenges for the Labor Market of the 21st Century 62045, Verein für Socialpolitik / German Economic Association.
  2. António Portugal Duarte & João Sousa Andrade & Adelaide Duarte, 2013. "Exchange Rate Target Zones: A Survey Of The Literature," Journal of Economic Surveys, Wiley Blackwell, Wiley Blackwell, vol. 27(2), pages 247-268, 04.
  3. Dick, Christian D. & Menkhoff, Lukas, 2013. "Exchange rate expectations of chartists and fundamentalists," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 37(7), pages 1362-1383.
  4. Antony Jackson & Daniel Ladley, 2013. "Market Ecologies: The Interaction and Profitability of Technical Trading Strategies," Discussion Papers in Economics, Department of Economics, University of Leicester 13/02, Department of Economics, University of Leicester.
  5. Roberto Dieci & Frank Westerhoff, 2012. "A simple model of a speculative housing market," Journal of Evolutionary Economics, Springer, Springer, vol. 22(2), pages 303-329, April.
  6. Hommes, Cars, 2011. "The heterogeneous expectations hypothesis: Some evidence from the lab," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 35(1), pages 1-24, January.
  7. Grosche, Stephanie & Heckelei, Thomas, 2014. "Price dynamics and financialization effects in corn futures markets with heterogeneous traders," Discussion Papers, University of Bonn, Institute for Food and Resource Economics 172077, University of Bonn, Institute for Food and Resource Economics.
  8. António Portugal Duarte & João Sousa Andrade & Adelaide Duarte, 2010. "Exchange Rate and Interest Rate Distribution and Volatility under the Portuguese Target Zone," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 57(3), pages 261-282, September.
  9. Miller, J. Isaac, 2011. "Testing the bounds: Empirical behavior of target zone fundamentals," Economic Modelling, Elsevier, Elsevier, vol. 28(4), pages 1782-1792, July.
  10. Stefan Reitz & Jan-Christoph Rülke & Georg Stadtmann, 2011. "Nonlinear Expectations in Speculative Markets - Evidence from the ECB Survey of Professional Forecasters," Kiel Working Papers 1706, Kiel Institute for the World Economy.
  11. Barunik, J. & Vosvrda, M., 2009. "Can a stochastic cusp catastrophe model explain stock market crashes?," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 33(10), pages 1824-1836, October.
  12. Lee, Hsiu-Yun, 2011. "Nonlinear exchange rate dynamics under stochastic official intervention," Economic Modelling, Elsevier, Elsevier, vol. 28(4), pages 1510-1518, July.
  13. Dieci, Roberto & Westerhoff, Frank, 2010. "Heterogeneous speculators, endogenous fluctuations and interacting markets: A model of stock prices and exchange rates," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 34(4), pages 743-764, April.

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