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BUBBLES IN FOREIGN EXCHANGE MARKETS

It Takes Two to Tango

Published online by Cambridge University Press:  08 November 2007

ALAN KIRMAN ,
ROMAIN FABIO RICCIOTTI  and
RICHARD LÉON TOPOL
ALAN KIRMAN
Affiliation:
GREQAM, Université d'Aix-Marseille III École des Hautes Études en Sciences Sociales
ROMAIN FABIO RICCIOTTI
Affiliation:
GREQAM, Université d'Aix-Marseille III École des Hautes Études en Sciences Sociales
RICHARD LÉON TOPOL
Affiliation:
CREA, CNRS
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Abstract

We consider a model in which foreign and domestic traders buy the assets of both of two countries. Speculators in both countries use chartist or fundamentalist rules for forecasting the exchange rate. Demand for the assets of each country is determined by these forecasts. Perceptions of the fundamentals in each country are not necessarily the same. Rules are used with a certain probability depending on an agent's previous experience with them. The demands of the fundamentalist and chartist agents in the two countries determine the temporary equilibrium exchange rate at each point in time. This is unique under certain assumptions. With traders of both nationalities there is no need, as in other models, for an exogenous supply of foreign exchange. The model produces realistic features of the equilibrium exchange rate series. Periods in which the exchange rate tracks the fundamentals of one of the countries alternate with others in which bubbles appear.

Keywords

Exchange RatesForecasting RulesHerdingTemporary EquilibriumSwitchingFundamentalsBubbles
Type
ARTICLES
Information
Macroeconomic Dynamics , Volume 11 , Supplement S1: Interacting Agents and Market Behavior , November 2007 , pp. 102 - 123
Copyright
© 2007 Cambridge University Press

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