Heterogeneous Expectations in the Foreign Exchange Market

Topics:
Reporting and Control,
Strategic Planning and Analysis
Tags:
Center For Financial Studies,
Currency & Foreign Exchange,
Finance,
Foreign-exchange,
Free Trade,
Regime
Source:
Center for Financial Studies

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Overview: In this study a regime switching approach is applied to estimate the chartist and fundamentalist (c&f) exchange rate model originally proposed by Frankel and Froot (1986). The c&f model is tested against alternative regime switching specifications applying likelihood ratio tests. Nested theoretical models like the popular segmented trends model suggested by Engel and Hamilton (1990) are rejected in favor of the multi agent model. Moreover, the c&f regime switching model seems to describe the data much better than a competing regime switching GARCH(1,1) model. Finally, the findings turned out to be relatively robust when estimating the model in sub samples. The empirical results suggest that the model is able to explain daily DM/Dollar forward exchange rate dynamics from 1982 to 1998.

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Format: PDF | Size: 205KB | Date: Mar 2003 | Pages: 30

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