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Uncertainty Aversion in a Heterogeneous AgentModel of Foreign Exchange Rate Formation

  • Mark Salmon
  • Roman Kozhan

This paper provides what we believe to be the first empirical test of whether investors in the foreign exchange market are uncertainty averse. We do this using a heterogeneous agents model in which fundamentalist and chartist beliefs of the exchange rate co-exist and are allowed to be either uncertainty neutral or uncertainty averse. Uncertainty aversion is modelled using the maxmin expected utility approach. We find significant evidence of uncertainty aversion in the FX market where in particular fundamentalists are found to be largely uncertainty neutral while chartists are mainly uncertainty averse. Inclusion of uncertainty averse agents significantly improves the empirical performance of the model.

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File URL: http://www2.warwick.ac.uk/fac/soc/wbs/research/wfri/rsrchcentres/ferc/wrkingpaprseries/fwp08-05.pdf
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Paper provided by Warwick Business School, Finance Group in its series Working Papers with number wp08-05.

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Date of creation: 2008
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Handle: RePEc:wbs:wpaper:wp08-05
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