Can the Interaction between a Single Long-Term Attractor and Heterogeneous Trading Explain the Exchange Rate Conundrum?

29 Pages Posted: 29 Jul 2017

See all articles by Giulio Cifarelli

Giulio Cifarelli

DISEI University of Florence

Giovanna Paladino

IntesaSanpaolo; LUISS Economics Department

Date Written: July 28, 2017

Abstract

Over the last 15 years, exchange rate movements have been smoother and slower than expected, given the entity of the sharp shifts in the fundamental variables brought about by the international financial crisis. Since the beginning of the ’90s researchers have explored different approaches in order to understand high frequency exchange rate dynamics. Among them the model that assumes heterogeneous trading strategies, where ‘fundamentalists’ coexist with ‘chartists’ in nonlinear transitional specifications, plays an increasingly relevant if puzzling role.

We study the US dollar, the British pound and the Japanese yen vs the euro over the period 2002 to 2016 using weekly data. The most important contribution of this paper is that we find empirical evidence that both types of agent react to the same transition variable, viz. the absolute distance of the actual exchange rate to its relative PPP value. The spot foreign currency demand of fundamentalists is driven by the size of the misalignment both directly and through a transition function, which models the adoption of fundamental strategies by newcomers. The number of chartists also varies according to the absolute distance of the exchange rate change from its fundamental value. Evidence supports the existence of stabilizing and destabilizing behaviour not only by chartists but also by fundamentalists.

Keywords: Exchange Rates, Heterogeneous Agents, Nonlinearity, LSTAR–GARCH Model

JEL Classification: E58, F31, G15

Suggested Citation

Cifarelli, Giulio and Paladino, Giovanna, Can the Interaction between a Single Long-Term Attractor and Heterogeneous Trading Explain the Exchange Rate Conundrum? (July 28, 2017). Available at SSRN: https://ssrn.com/abstract=3010085 or http://dx.doi.org/10.2139/ssrn.3010085

Giulio Cifarelli

DISEI University of Florence ( email )

via delle Pandette 9
Florence 50127
Italy

Giovanna Paladino (Contact Author)

IntesaSanpaolo ( email )

Piazza San Carlo
Torino, 10121
Italy

LUISS Economics Department ( email )

Viale di Villa Massimo, 57
Rome, 00161
Italy

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