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Adaptive Learning in an Expectational Difference Equation with Several Lags: Selecting among Learnable REE

  • Mikael Bask

"It is demonstrated that adaptive learning in the least squares sense may be incapable of satisfactorily reducing the number of attainable equilibria in a rational expectations model when focusing on the forward-solutions to the model. The model examined, as an illustration, is a basic asset pricing model for exchange rate determination that is augmented with technical trading in the currency market in the form of moving averages since it is the most commonly used technique according to questionnaire surveys. The forward-solutions to such a model are preferable to the backward-solutions that are normally utilized since announcement effects is an important feature in currency trade. Because of technical trading in foreign exchange, the current exchange rate depends on" "j" max "lags of the exchange rate, meaning that the model has" "j" max + 1"rational expectations equilibria, where several of them are adaptively learnable in the least squares sense. However, since past exchange rates should not affect the current exchange rate when technical trading is absent, it is possible to single out a unique equilibrium among the adaptively learnable equilibria that is economically meaningful. It is worth noting that the model examined can also be viewed as a model for stock price determination in which the forward-solutions to the model are preferable to the backward-solutions since the importance of announcement effects is a common characteristic for currency and stock markets." Copyright 2007 The Author Journal compilation (c) Blackwell Publishing Ltd.

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Article provided by European Financial Management Association in its journal European Financial Management.

Volume (Year): 14 (2008)
Issue (Month): 1 ()
Pages: 99-117

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Handle: RePEc:bla:eufman:v:14:y:2008:i:1:p:99-117
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  1. Lui, Yu-Hon & Mole, David, 1998. "The use of fundamental and technical analyses by foreign exchange dealers: Hong Kong evidence," Journal of International Money and Finance, Elsevier, vol. 17(3), pages 535-545, June.
  2. Bennett T. McCallum, 1981. "On Non-Uniqueness in Rational Expectations Models: An Attempt at Perspective," NBER Working Papers 0684, National Bureau of Economic Research, Inc.
  3. Yin-Wong Cheung & Menzie D. Chinn, 2000. "Currency Traders and Exchange Rate Dynamics: A Survey of the U.S. Market," CESifo Working Paper Series 251, CESifo Group Munich.
  4. Bask , Mikael, 2006. "Announcement effects on exchange rate movements: continuity as a selection criterion among the REE," Research Discussion Papers 6/2006, Bank of Finland.
  5. Oberlechner, Thomas, 2001. "Importance of Technical and Fundamental Analysis in the European Foreign Exchange Market," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 6(1), pages 81-93, January.
  6. Menkhoff, Lukas, 1997. "Examining the Use of Technical Currency Analysis," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 2(4), pages 307-18, October.
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