Exchange Rate Dynamics with Chartists, Fundamentalists and Rational Speculators in the Foreign Exchange Market

This paper extends previous work on speculative dynamics in the foreign exchange market. The analysis shows how the behavior of chartists, fundamentalists and rational speculators, together with uncertainty about the long-run equilibrium exchange rate level, can result in fluctuations of the spot rate triggered by a random shock to the market. Although the exact exchange rate path depends on the extent of the shock and on specific values of model parameters, the heterogeneity of expectations can explain several characteristics of short-term exchange rate developments, which have often been emphasized in empirical studies on exchange rate dynamics