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Fundamental and Non-Fundamental Equilibria in the Foreign Exchange Market. A Behavioural Finance Framework

Author

Listed:
  • Paul de Grauwe
  • Roberto Dieci
  • Marianna Grimaldi
  • Paul De Grauwe

Abstract

We develop a simple model of the exchange rate in which agents optimize their portfolio and use different forecasting rules. They check the profitability of these rules ex post and select the more profitable one. This model produces two kinds of equilibria, a fundamental and a bubble one. In a stochastic environment the model generates a complex dynamics in which bubbles and crashes occur at unpredictable moments. We contrast these ”behavioural” bubbles with ”rational” bubbles.

Suggested Citation

  • Paul de Grauwe & Roberto Dieci & Marianna Grimaldi & Paul De Grauwe, 2005. "Fundamental and Non-Fundamental Equilibria in the Foreign Exchange Market. A Behavioural Finance Framework," CESifo Working Paper Series 1431, CESifo.
    • Handle: RePEc:ces:ceswps:_1431
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    References listed on IDEAS

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    Cited by:

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    2. Gonzales-Eiras, Martín & Niepelt, Dirk, 2004. "Sustaining Social Security," Seminar Papers 731, Stockholm University, Institute for International Economic Studies.
    3. Simiso MSOMI & Harold NGALAWA, 2023. "The Movement of Exchange Rate and Expected Income: Case of South Africa," Journal of Economics and Financial Analysis, Tripal Publishing House, vol. 7(2), pages 65-89.

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    Keywords

    exchange rate; bounded rationality; heterogeneous agents; bubbles and crashes; complex dynamics; basins of attraction;
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