Dispersion of Beliefs and Market Volatility in the Foreign Exchange Market
33 Pages Posted: 8 Mar 2006
Date Written: June 2006
This paper examines the existence of heterogeneous expectations among market participants in the foreign exchange market by using a data set of individual market expectations for the major currencies, and approaches the formation of expectations from a bounded-rationality approach. We find that that there are distinct periods of high and low dispersion in which market participants disagree as to what will happen to the future level of the exchange rates. Furthermore, we document that the frequency at which extremist differences in expectations among market participants occurs, is higher than that what would occur under normality. Dispersion of beliefs seems to occur as a result of the combined effects of market participants holding individual expectations and attaching different weights on various elements from their information sets. Finally, we find that market volatility Granger-causes trader heterogeneity.
Keywords: Exchange rate expectations, heterogeneity, dispersion of beliefs, bounded rationality, tail behaviour, survey data
JEL Classification: F31
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