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Nonlinear exchange rate dynamics and behavioral expectations: New evidence from selected emerging and advanced economies

Author

Listed:
  • Lorenzo Biondi

    (University of Siena)

  • Christian R. Proaño

    (Otto-Friedrich-Universität Bamberg
    Australian National University, Centre for Applied Macroeconomic Analysis)

Abstract

Uncovered interest parity (UIP) is routinely rejected at short horizons, motivating departures toward heterogeneous-expectations frameworks. We estimate a behavioral UIP (BUIP) law of motion for monthly exchange-rate returns, where expectations form as a profitability-weighted average of a chartist (trend-following) rule and a fundamentalist rule anchored to absolute purchasing power parity (PPP). Building on Proaño (2011, 2013), rule shares evolve through a discrete-choice mechanism. We compare the structural BUIP against a reduced-form logistic smooth-transition regression across fourteen bilateral USD exchange rates (seven advanced, seven emerging) from the early 1980s to 2025. We reject linearity for 13 of 14 currencies, with nonlinear models reducing in-sample fit. However, the Akaike information criterion frequently prefers the linear benchmark in advanced economies, suggesting nonlinearity is most rewarded in emerging markets. The structural BUIP identifies stabilizing PPP-consistent mean reversion in seven countries. While embedding heterogeneous beliefs into UIP partly reconciles the parity condition with nonlinear dynamics, the mixed evidence on PPP correction highlights the limitations of a “one-model-fits-all” approach. Ultimately, the choice of fundamental anchor appears to be highly market- and time-dependent.

Suggested Citation

  • Lorenzo Biondi & Christian R. Proaño, 2026. "Nonlinear exchange rate dynamics and behavioral expectations: New evidence from selected emerging and advanced economies," Journal of Evolutionary Economics, Springer, vol. 36(2), pages 1-48, August.
    • Handle: RePEc:spr:joevec:v:36:y:2026:i:2:d:10.1007_s00191-026-00970-9
    DOI: 10.1007/s00191-026-00970-9
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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection

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