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Adaptive learning in an expectational difference equation with several lags: selecting among learnable REE

  • Bask, Mikael

    ()

    (Bank of Finland Research)

It is demonstrated in this paper that adaptive learning in least squares sense may be incapable to reduce, in a satisfactory way, the number of attainable equilibria in a rational expectations model. The model inves-tigated, as an illustration, is the monetary approach to 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. Because of technical trading in foreign exchange, the current exchange rate is dependent on jmax lags of the exchange rate, and the model has, therefore jmax + 1 nonbubble rational expectations equilibria (REE), where most of them are adaptively learnable. Howe-ver, by assuming that a solution to the model should have a solution to a nested model as its limit, it is possible to single out a unique equilibrium among the adaptively learnable equilibria that is economically meaningful.

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File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/0607netti.pdf
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Paper provided by Bank of Finland in its series Research Discussion Papers with number 7/2006.

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Length: 37 pages
Date of creation: 07 Jun 2006
Date of revision:
Handle: RePEc:hhs:bofrdp:2006_007
Contact details of provider: Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
Web page: http://www.suomenpankki.fi/en/

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  1. 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.
  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. 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.
  4. 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.
  5. 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.
  6. 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.
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