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Switching Between Chartists and Fundamentalists: A Markov Regime-Switching Approach

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  • Robert Vigfusson

Abstract

Since the early 1980s, models based on economic fundamentals have been poor at explaining the movements in the exchange rate (Messe 1990). In response to this problem, Frankel and Froot (1988) developed a model that uses two approaches to forecast the exchange rate: the fundamentalist approach, which bases the forecast on economic fundamentals, and the chartist approach, which bases the forecast on the past behaviour of the exchange rate. This was an innovation, as only the fundamentalist approach had been used before. A feature of the chartist-and-fundamentalist (c&f) model is that these two approaches' relative importance varies over time. Because this weighting is unobserved, the c&f model can not be estimated or tested using standard techniques. To overcome these difficulties and to test the model, the author uses Markov regime-switching techniques. He defines the two groups' different methods of forecasting as regimes and rewrites the c&f model as a regime-switching model. The model is then used to test for c&f behaviour in the Canada-U.S. daily exchange rate between 1983 and 1992. The author finds favourable though inconclusive evidence for the c&f model and accordingly makes suggestions for further research.

Suggested Citation

  • Robert Vigfusson, 1996. "Switching Between Chartists and Fundamentalists: A Markov Regime-Switching Approach," International Finance 9602003, EconWPA.
  • Handle: RePEc:wpa:wuwpif:9602003
    Note: 22 printed pages, compressed PostScript file. Other recent Bank of Canada working papers are listed on the last page of this report.
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    References listed on IDEAS

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    1. Hansen, Bruce E, 1992. "The Likelihood Ratio Test under Nonstandard Conditions: Testing the Markov Switching Model of GNP," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 7(S), pages 61-82, Suppl. De.
    2. Engel, Charles, 1994. "Can the Markov switching model forecast exchange rates?," Journal of International Economics, Elsevier, vol. 36(1-2), pages 151-165, February.
    3. Alain DeSerres & Alain Guay & Pierre St-Amant, 1995. "Estimating and Projecting Potential Output Using Structural VAR Methodology," Macroeconomics 9504003, EconWPA.
    4. Cutler, David M & Poterba, James M & Summers, Lawrence H, 1990. "Speculative Dynamics and the Role of Feedback Traders," American Economic Review, American Economic Association, vol. 80(2), pages 63-68, May.
    5. Robert A. Amano & Tony S. Wirjanto, "undated". "An Empirical Investigation into Government Spending and Private Sector Behaviour," Staff Working Papers 94-8, Bank of Canada.
    6. Amano, Robert A. & van Norden, Simon, 1995. "Terms of trade and real exchange rates: the Canadian evidence," Journal of International Money and Finance, Elsevier, vol. 14(1), pages 83-104, February.
    7. 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.
    8. Brock, William & Lakonishok, Josef & LeBaron, Blake, 1992. " Simple Technical Trading Rules and the Stochastic Properties of Stock Returns," Journal of Finance, American Finance Association, vol. 47(5), pages 1731-1764, December.
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    More about this item

    JEL classification:

    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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