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Asset prices and exchange rates: a time dependent approach

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  • Giulia PICCILLO

Abstract

This paper studies the relationship between exchange rates and asset prices. It takes the novel approach of modeling both the markets in a framework of heterogeneous agents. Investors maximize their profits from the international equity markets by solving a Mean-Variance problem. As a result, agents choose between different combinations of rules in the home and foreign equity market as well as in the foreign exchange market. Given the incomplete information setting, agents check the past profitability of their rules and switch behavior in the effort to maximize their profits. Due to the heuristics embedded within the model, this simple frame-work alone is able to create a complex, time-varying dynamics. This dynamics is analyzed for different parameters and conditions. Finally the model is brought to the data, to check the fitness of the predictions on the real world markets.

Suggested Citation

  • Giulia PICCILLO, 2009. "Asset prices and exchange rates: a time dependent approach," Working Papers Department of Economics ces09.03, KU Leuven, Faculty of Economics and Business, Department of Economics.
  • Handle: RePEc:ete:ceswps:ces09.03
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    Keywords

    Behavioral finance; exchange rates; asset prices;

    JEL classification:

    • C2 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables
    • F3 - International Economics - - International Finance
    • G1 - Financial Economics - - General Financial Markets

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