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Expectation formation mechanisms, profitability of foreign exchange trading and exchange rate volatility

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  • Imad Moosa
  • Abul Shamsuddin

Abstract

An attempt is made to identify the expectation formation mechanism dominating the foreign exchange market and to demonstrate that exchange rate volatility can be attributed to the heterogeneity of traders with respect to expectation formation. The criterion used to identify the dominance of a particular mechanism is the profitability of trading based on that mechanism. It is concluded that mixed and extrapolative expectations are the dominant mechanisms, that market participants follow some sort of a herd behaviour, and that they pay attention to the expectations of other participants. It is also found that the heterogeneity of market participants with respect to expectation formation goes a long way towards explaining volatility.

Suggested Citation

  • Imad Moosa & Abul Shamsuddin, 2004. "Expectation formation mechanisms, profitability of foreign exchange trading and exchange rate volatility," Applied Economics, Taylor & Francis Journals, vol. 36(14), pages 1599-1606.
    • Handle: RePEc:taf:applec:v:36:y:2004:i:14:p:1599-1606
    DOI: 10.1080/0003684042000217977
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    References listed on IDEAS

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    6. MacDonald, Ronald & Torrance, T S, 1988. "On Risk, Rationality and Excessive Speculation in the Deutschmark-U.S. Dollar Exchange Market: Some Evidence Using Survey Data," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 50(2), pages 107-123, May.
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    Cited by:

    1. Lukas Menkhoff & Rafael Rebitzky & Michael Schroder, 2008. "Do dollar forecasters believe too much in PPP?," Applied Economics, Taylor & Francis Journals, vol. 40(3), pages 261-270.
    2. Anastasiou, Dimitrios, 2020. "Senior bank loan officers' expectations for loan demand: Evidence from the Euro-area," MPRA Paper 98903, University Library of Munich, Germany.
    3. Dimitrios Anastasiou & Stelios Giannoulakis, 2021. "Are firms' expectations on the availability of external finance rational, adaptive or regressive?," Journal of Economic Studies, Emerald Group Publishing Limited, vol. 49(5), pages 833-849, June.

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