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Currency Market Participants' Mental Model and the Collapse of the Dollar: 2001-2008

  • John T. Harvey

It is well accepted among Institutionalist and Post Keynesian scholars that portfolio investment markets are driven by agents' expectations rather than "the fundamentals." This explains, it is argued, why asset and currency prices are so much more volatile than and often clearly out of line with what we would otherwise consider to be their underlying determinants. What is rarely addressed, however, is how those expectations are formed. This paper fills the void by proposing a specific view of agents' expectations based on the mental model they employ to understand currency movements. The paper derives this schematic by examining market participants' psychological propensities and the world view of the subculture of which they are members. It will be shown that the model is consistent with the salient features of the foreign exchange market and it is employed to explain the dollar's fall from 2001 through 2008.

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Article provided by M.E. Sharpe, Inc. in its journal Journal of Economic Issues.

Volume (Year): 43 (2009)
Issue (Month): 4 (December)
Pages: 931-949

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Handle: RePEc:mes:jeciss:v:43:y:2009:i:4:p:931-949
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  1. Imad A. Moosa, 2007. "Neoclassical versus Post Keynesian models of exchange rate determination: a comparison based on nonnested model selection tests and predictive accuracy," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 30(2), pages 169-185, December.
  2. Imad A. Moosa, 2004. "An empirical examination of the Post Keynesian view of forward exchange rates," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 26(3), pages 395-418, April.
  3. John T. Harvey, 1993. "Daily Exchange Rate Variance," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 15(4), pages 515-540, July.
  4. Yin-Wong Cheung & Menzie D. Chinn & Ian W. Marsh, 2000. "How Do UK-Based Foreign Exchange Dealers Think Their Market Operates?," NBER Working Papers 7524, National Bureau of Economic Research, Inc.
  5. Ederington, Louis H & Lee, Jae Ha, 1993. " How Markets Process Information: News Releases and Volatility," Journal of Finance, American Finance Association, vol. 48(4), pages 1161-91, September.
  6. John Harvey, 2001. "The Determinants of Currency Market Forecasts: An Empirical Study," Working Papers 200102, Texas Christian University, Department of Economics.
  7. John Harvey, 2001. "Psychological and Institutional Forces and the Determination of Exchange Rates," Working Papers 200101, Texas Christian University, Department of Economics.
  8. Thomas Gehrig & Lukas Menkhoff, 2005. "The Rise of Fund Managers in Foreign Exchange:Will Fundamentals Ultimately Dominate?," The World Economy, Wiley Blackwell, vol. 28(4), pages 519-540, 04.
  9. John T. Harvey, 2004. "Deviations from uncovered interest rate parity: a Post Keynesian explanation," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 27(1), pages 19-35, October.
  10. Stephan Schulmeister, 1988. "Currency speculation and dollar fluctuations," Banca Nazionale del Lavoro Quarterly Review, Banca Nazionale del Lavoro, vol. 41(167), pages 343-365.
  11. Taylor, Mark P. & Allen, Helen, 1992. "The use of technical analysis in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 11(3), pages 304-314, June.
  12. Hiroya Akiba, 2004. "Expectations, stability, and exchange rate dynamics under the Post Keynesian hypothesis," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 27(1), pages 125-140, October.
  13. Imad A. Moosa, 2002. "A Test of the Post Keynesian Hypothesis on Expectation Formation in the Foreign Exchange Market," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 24(3), pages 443-457, April.
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