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Revisiting Paul de Grauwe’s Chaotic Exchange Rate Model: New Analytical Insights and Agent-Based Explorations

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  • Sarah Mignot

    (University of Bamberg)

  • Frank Westerhoff

    (University of Bamberg)

Abstract

We apply recent stability and bifurcation results to provide an analytical characterization of Paul de Grauwe’s chaotic exchange rate model. We prove that the model’s fundamental steady state becomes unstable due to a Neimark-Sacker bifurcation when chartists extrapolate past exchange rate trends too strongly, a phenomenon that gives rise to cyclical exchange rate dynamics. In contrast, fundamentalists’ mean reversion strength only has a stabilizing effect on the model’s dynamics when the exchange rate is out of equilibrium. We also show that agent-based versions of Paul de Grauwe’s exchange rate model may produce endogenous exchange rate dynamics, too.

Suggested Citation

  • Sarah Mignot & Frank Westerhoff, 2023. "Revisiting Paul de Grauwe’s Chaotic Exchange Rate Model: New Analytical Insights and Agent-Based Explorations," Open Economies Review, Springer, vol. 34(1), pages 155-169, February.
    • Handle: RePEc:kap:openec:v:34:y:2023:i:1:d:10.1007_s11079-022-09667-5
    DOI: 10.1007/s11079-022-09667-5
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    References listed on IDEAS

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    1. Day, Richard H. & Huang, Weihong, 1990. "Bulls, bears and market sheep," Journal of Economic Behavior & Organization, Elsevier, vol. 14(3), pages 299-329, December.
    2. Manzan, Sebastiano & Westerhoff, Frank H., 2007. "Heterogeneous expectations, exchange rate dynamics and predictability," Journal of Economic Behavior & Organization, Elsevier, vol. 64(1), pages 111-128, September.
    3. Roberto Dieci & Xue-Zhong He, 2018. "Heterogeneous Agent Models in Finance," Research Paper Series 389, Quantitative Finance Research Centre, University of Technology, Sydney.
    4. Westerhoff, Frank, 2003. "Speculative markets and the effectiveness of price limits," Journal of Economic Dynamics and Control, Elsevier, vol. 28(3), pages 493-508, December.
    5. Lukas Menkhoff & Mark P. Taylor, 2007. "The Obstinate Passion of Foreign Exchange Professionals: Technical Analysis," Journal of Economic Literature, American Economic Association, vol. 45(4), pages 936-972, December.
    6. Hommes,Cars, 2015. "Behavioral Rationality and Heterogeneous Expectations in Complex Economic Systems," Cambridge Books, Cambridge University Press, number 9781107564978.
    7. Paul Grauwe & Hans Dewachter, 1993. "A chaotic model of the exchange rate: The role of fundamentalists and chartists," Open Economies Review, Springer, vol. 4(4), pages 351-379, December.
    8. Marji Lines & Noemi Schmitt & Frank Westerhoff, 2020. "Stability conditions for three-dimensional maps and their associated bifurcation types," Applied Economics Letters, Taylor & Francis Journals, vol. 27(13), pages 1056-1060, June.
    9. Paul Grauwe, 2011. "Animal spirits and monetary policy," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 47(2), pages 423-457, June.
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    Cited by:

    1. Mignot, Sarah & Westerhoff, Frank H., 2023. "Explaining the stylized facts of foreign exchange markets with a simple agent-based version of Paul de Grauwe's chaotic exchange rate model," BERG Working Paper Series 189, Bamberg University, Bamberg Economic Research Group.

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    More about this item

    Keywords

    Foreign exchange markets; Exchange rate dynamics; Chartists and fundamentalists; Stability and bifurcation analysis; Agent-based modeling;
    All these keywords.

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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