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Nonlinearities and Cyclical Behavior: The Role of Chartists and Fundamentalists

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  • Westerhoff Frank H.

    (University of Osnabrueck)

  • Reitz Stefan

    (University of Giessen)

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.

Suggested Citation

  • Westerhoff Frank H. & Reitz Stefan, 2003. "Nonlinearities and Cyclical Behavior: The Role of Chartists and Fundamentalists," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 7(4), pages 1-15, December.
    • Handle: RePEc:bpj:sndecm:v:7:y:2003:i:4:n:3
    DOI: 10.2202/1558-3708.1125
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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation

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