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Psychological and Institutional Forces and the Determination of Exchange Rates

Author

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  • John Harvey

    () (Department of Economics, Texas Christian University)

Abstract

Neoclassical economists have, by their own admission, had a terrible time explaining foreign- currency prices. Not only have they been unable to develop models that explain the past time series of foreign exchange rates with any regularity but their premises lead to conclusions about the character of the market that are inconsistent with many of its salient features. Mainstream approaches cannot, for example, account for exchange rate volatility, nonrational expectations, or the popularity of technical analysis. It is my contention that neoclassicists’ failure can be traced in large part to their assumption that economic behavior is independent of social, psychological, and cultural influences and is instead driven by rational and presumably natural free market impulses. The purpose of this paper is to show that an explanation of exchange rate determination that places the activity in its psychosocial context yields results superior to those of one based on traditional neoclassical principles. In particular, it will be shown that if agents’ behavior is modeled as being a function of their socialization in the capitalist system (and subsequent molding within the subculture of portfolio investors) and if their forecasting and decision-making processes are assumed to be driven by the same factors as theorized by psychologists (rather than economists), then the picture that emerges is one wherein bandwagon effects are common, periods of volatility are to be expected, and predictions can contain persistent bias.

Suggested Citation

  • John Harvey, 2001. "Psychological and Institutional Forces and the Determination of Exchange Rates," Working Papers 200101, Texas Christian University, Department of Economics.
  • Handle: RePEc:tcu:wpaper:200101
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    Download full text from publisher

    File URL: http://www.econ.tcu.edu/RePEc/tcu/wpaper/wp01-01.pdf
    File Function: First version, 2001
    Download Restriction: no

    References listed on IDEAS

    as
    1. Stephan Schulmeister, 1988. "Currency speculation and dollar fluctuations," Banca Nazionale del Lavoro Quarterly Review, Banca Nazionale del Lavoro, vol. 41(167), pages 343-365.
    2. repec:mes:jeciss:v:31:y:1997:i:2:p:615-622 is not listed on IDEAS
    3. 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.
    4. Suvanto, Antti, . "Foreign Exchange Dealing. Essays on the Microstructure of the Foreign Exchange Market," ETLA A, The Research Institute of the Finnish Economy, number 19.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Khuram Shafi & Liu Hua & Amna Nazeer & Zahra Idrees, 2015. "Behavior of Exchange Rate Volatility: Once Again in Action," International Journal of Academic Research in Business and Social Sciences, Human Resource Management Academic Research Society, International Journal of Academic Research in Business and Social Sciences, vol. 5(1), pages 270-276, January.
    2. John Harvey, 2009. "Currency Market Participants' Mental Model and the Collapse of the Dollar: 2001-2008," Journal of Economic Issues, Taylor & Francis Journals, vol. 43(4), pages 931-949.

    More about this item

    Keywords

    exchange rates; pyschology; social; institutionalist;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • B52 - Schools of Economic Thought and Methodology - - Current Heterodox Approaches - - - Historical; Institutional; Evolutionary

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