Article2003

Nonlinearities and Cyclical Behavior: The Role of Chartists and Fundamentalists

125 citations0/0 files storedStudies in Nonlinear Dynamics and Econometrics

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Financial Markets and Investment Strategies Monetary Policy and Economic Impact Economic theories and models

Abstract

We develop a behavioral exchange rate model with chartists and fundamentalists to study cyclical behavior in foreign exchange markets. Within our model, the market impact of fundamentalists depends on the strength of their belief in fundamental analysis. Estimation of a STAR GARCH model shows that the more the exchange rate deviates from its fundamental value, the more fundamentalists leave the market. In contrast to previous findings, our paper indicates that due to the nonlinear presence of fundamentalists, market stability decreases with increasing misalignments. A stabilization policy such as central bank interventions may help to deflate bubbles.

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References

1990Noise Trader Risk in Financial Markets 1992Quasi-maximum likelihood estimation and inference in dynamic models with time-varying covariances 1998Heterogeneous beliefs and routes to chaos in a simple asset pricing model 1992The use of technical analysis in the foreign exchange market 2001Nonlinear Mean‐Reversion in Real Exchange Rates: Toward a Solution To the Purchasing Power Parity Puzzles 1992Characterizing nonlinearities in business cycles using smooth transition autoregressive models 2000VOLATILITY CLUSTERING IN FINANCIAL MARKETS: A MICROSIMULATION OF INTERACTING AGENTS 1990Bulls, bears and market sheep

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