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Nonlinearities and Cyclical Behavior: The Role of Chartists and Fundamentalists

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.
Year of publication:
2007
Authors: Westerhoff, Frank ; Reitz, Stefan
Published in:
Studies in Nonlinear Dynamics & Econometrics. - Berkeley Electronic Press. - Vol. 7.2007, 4, p. 1125-1125
Publisher: Berkeley Electronic Press
Subject: nonlinearities | cyclical behavior | technical and fundamental trading | STAR GARCH
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Type of publication: Article
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