Narrow Results

The following sections are included:

• Introduction
• A Simple Non-Linear Exchange Rate Model
• The Model with Transactions Costs
• Solution of the Model
• Sensitivity Analysis
• The Stochastic Version of the Model
• The Effect of Permanent Shocks
• Empirical Relevance of the Model
• Is Chartism Evolutionary Stable?
• Conclusion
• Appendix 1: Diagnosis of GARCH Structure in the Simulated Exchange Rate Returns
• References

The rational expectations efficient market model of the exchange rate has failed empirically. In this paper, we develop a model of the exchange rate in which agents use simple forecasting rules. Based on an ex post evaluation of the relative profitability of these rules they decide whether to switch or not. In addition, transactions costs in the goods market are introduced. We show that this simple model creates great complexity in the market which is characterised by the fact that the exchange rate is disconnected from its fundamental most of the time. Finally, we show that this model mimicks most of the empirical puzzles uncovered in the literature.

In this paper, we analyze the effectiveness of the direct central bank interventions using a new effectiveness criterion. To this aim, we investigate the effects of central bank interventions (CBI) in a noise trading model with chartists and fundamentalists. We first estimate a model in which chartists extrapolate past returns and fundamentalists forecast a mean reverting dynamics of the exchange rate toward a fundamental value. Then, we investigate the role of central bank interventions for explaining the switching properties between the two types of agents. We find evidence showing that in the medium run, interventions increase the proportion of fundamentalists and therefore exert some stabilizing influence on the exchange rate.