Heterogeneous Expectations, Exchange Rate Dynamics and Predictability

27 Pages Posted: 4 Feb 2009

See all articles by Sebastiano Manzan

Sebastiano Manzan

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance

Frank H. Westerhoff

affiliation not provided to SSRN

Date Written: September 16, 2008

Abstract

This paper proposes a simple chartist-fundamentalist model in which we allow for nonlinear time variation in chartists' extrapolation rate. Estimation of the model using monthly data for the major currencies vis-a-vis the US dollar shows that the model is significant in-sample and that it has out-of-sample predictive power for some of the currencies. We investigate the power of tests used in the literature to detect predictability against the alternative of the proposed model. We find that the short-term unpredictability and the long-term predictability are consistent with the model. The short-term unpredictability might be caused by the presence of weak nonlinearities that are difficult to detect at available sample sizes.

Keywords: Exchange Rates, Heterogeneous Expectations, Forecasting, Nonlinear Models

JEL Classification: F31, C52, C53

Suggested Citation

Manzan, Sebastiano and Westerhoff, Frank H., Heterogeneous Expectations, Exchange Rate Dynamics and Predictability (September 16, 2008). Journal of Economic Behavior and Organization, Vol. 64, 2007, Available at SSRN: https://ssrn.com/abstract=1269055

Sebastiano Manzan (Contact Author)

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance ( email )

17 Lexington Avenue
New York, NY 10010
United States

Frank H. Westerhoff

affiliation not provided to SSRN