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Chaos and the exchange rate

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  • Daniela Federici
  • Giancarlo Gandolfo

Abstract

Chaotic exchange rate models are structural models built in discrete time (difference equations), and show that with orthodox assumptions (PPP, interest parity, etc) and introducing plausible nonlinearities in the dynamic equations, it is possible to obtain a model capable of giving rise to chaotic motion. However, none of these models is estimated, and the conclusions are based on simulations: the empirical validity of these models is not tested. In this paper, a continuous time (the exchange rate is obviously a continuous variable) exchange rate model is built as a non-linear set of three differential equations and its theoretical properties (steady state, stability, etc,) analysed. The model is then econometrically estimated in continuous time with Italian data and examined for the possible presence of chaotic motion. This paper also shows that the continuous time estimation of economic models built as systems of nonlinear differential equations is a very powerful tool in the hands of the profession.

Suggested Citation

  • Daniela Federici & Giancarlo Gandolfo, 2001. "Chaos and the exchange rate," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 11(2), pages 111-142.
    • Handle: RePEc:taf:jitecd:v:11:y:2001:i:2:p:111-142
    DOI: 10.1080/09638190010110712
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    1. Giancarlo Gandolfo & Pier Carlo Padoan & Giuseppe Arcangelis, 1993. "The Theory of Exchange Rate Determination, and Exchange Rate Forecasting," International Economic Association Series, in: Helmut Frisch & Andreas Wörgötter (ed.), Open-Economy Macroeconomics, chapter 18, pages 332-352, Palgrave Macmillan.
    2. Giancarlo Gandolfo, 2016. "International Finance and Open-Economy Macroeconomics," Springer Texts in Business and Economics, Springer, edition 2, number 978-3-662-49862-0, December.
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    6. Szpiro, George G., 1994. "Exchange rate speculation and chaos inducing intervention," Journal of Economic Behavior & Organization, Elsevier, vol. 24(3), pages 363-368, August.
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    8. Paul Grauwe & Hans Dewachter, 1993. "A chaotic model of the exchange rate: The role of fundamentalists and chartists," Open Economies Review, Springer, vol. 4(4), pages 351-379, December.
    9. Crespo Cuaresma, Jesus, 1998. "Deterministic Chaos versus Stochastic Processes," Economics Series 60, Institute for Advanced Studies.
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    Cited by:

    1. Daniela Federici & Giancarlo Gandolfo, 2011. "The Euro/Dollar Exchange Rate: Chaotic or Non-Chaotic?," CESifo Working Paper Series 3420, CESifo.
    2. Federici, Daniela & Gandolfo, Giancarlo, 2012. "The Euro/Dollar exchange rate: Chaotic or non-chaotic? A continuous time model with heterogeneous beliefs," Journal of Economic Dynamics and Control, Elsevier, vol. 36(4), pages 670-681.

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