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Heterogeneous Expectations and Exchange Rate Dynamics

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Abstract

This paper presents a continuous-time model of exchange rates relying not only on macroeconomic factors but also having a market microstructure component. The driving macroeconomic factor is the interest rate differential, while the market microstructure element is described by the expectations of boundedly rational portfolio managers who use a weighted average of the expectations of fundamentalists and chartists. Within this framework, the different roles of the macroeconomic factors and market microstructure elements on the determination of the exchange rate are examined explicitly. We show that this simple model generates very complicated market behaviour, including the existence of multiple steady state equilibria, the deviations of the market exchange rate from the fundamental, and market fluctuations. Numerical simulation of the corresponding stochastic version of the model shows that the model is able to generate typical time series and volatility clustering patterns observed in exchange rate markets.

Suggested Citation

  • Carl Chiarella & Xue-Zhong He & Min Zheng, 2009. "Heterogeneous Expectations and Exchange Rate Dynamics," Research Paper Series 243, Quantitative Finance Research Centre, University of Technology, Sydney.
    • Handle: RePEc:uts:rpaper:243
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    Cited by:

    1. Sensoy, Ahmet & Serdengeçti, Süleyman, 2020. "Impact of portfolio flows and heterogeneous expectations on FX jumps: Evidence from an emerging market," International Review of Financial Analysis, Elsevier, vol. 68(C).
    2. He, Xue-Zhong & Li, Youwei & Zheng, Min, 2019. "Heterogeneous agent models in financial markets: A nonlinear dynamics approach," International Review of Financial Analysis, Elsevier, vol. 62(C), pages 135-149.
    3. Soumya Datta, 2019. "Exchange rate dynamics under limits of arbitrage and heterogeneous expectations," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 14(3), pages 521-550, September.
    4. Wilson Sy, 2009. "Towards a national default option for low‐cost superannuation," Accounting Research Journal, Emerald Group Publishing Limited, vol. 22(1), pages 46-67, July.
    5. Peter Flaschel & Florian Hartmann & Christopher Malikane & Christian Proaño, 2015. "A Behavioral Macroeconomic Model of Exchange Rate Fluctuations with Complex Market Expectations Formation," Computational Economics, Springer;Society for Computational Economics, vol. 45(4), pages 669-691, April.
    6. Min Zheng & Duo Wang & Xue-Zhong He, 2009. "Asymmetry of technical analysis and market price volatility," Published Paper Series 2009-6, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
    7. Min Zheng, 2015. "Heterogeneous Expectations and Speculative Behavior in Insurance-Linked Securities," Discrete Dynamics in Nature and Society, Hindawi, vol. 2015, pages 1-12, March.

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    Keywords

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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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