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Heterogeneous Beliefs in a Sticky-Price Foreign Exchange Model

Introduction

Theoretical framework

Expectations formations

Formal analysis of the model

Adjustment path to longrun equilibrium

Perfect foresight path

Simulations of the model

Concluding discussion

Appendix

References

Table and Figures

Technical Analysis Advanced

Heterogeneous Beliefs in a Sticky-Price Foreign Exchange Model

Keywords :Exchange Rates , Technical Analysis

It is demonstrated in this paper that the exchange rate "overshoots the overshooting equilibrium" when chartists are introduced into a sticky-price monetary model due originally to Dornbusch (1976). Chartists are introduced since questionnaire surveys reveal that currency trade to a large extent is based on technical trading, where moving averages is the most commonly used technique.

Moreover, the surveys also reveal that the importance of technical trading depends inversely on the planning horizon in currency trade. Implementing these observations theoretically, and deriving the exchange rate's perfect foresight path near long-run equilibrium, it is also demonstrated in this paper that the shorter the planning horizon is, the larger the magnitude of exchange rate overshooting. Finally, the effects on the exchange rate's time path of changes in the model's structural parameters are derived.

Prof. Mikael Bask and Carina Selander

Umeå Economic Studies

Performance Trading

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