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Conventions in the foreign exchange market : Can they really explain exchange rate dynamics ?

Di Filippo, Gabriele (2011-01), Conventions in the foreign exchange market : Can they really explain exchange rate dynamics ?, 28th GdRE Annual International Symposium on Money, Banking and Finance, 2011-06, Reading, Royaume-Uni

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Type
Communication / Conférence
Date
2011-01
Conference title
28th GdRE Annual International Symposium on Money, Banking and Finance
Conference date
2011-06
Conference city
Reading
Conference country
Royaume-Uni
Pages
39
Metadata
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Author(s)
Di Filippo, Gabriele
Abstract (EN)
The present article provides an unorthodox model exchange rate dynamics based on conventions that prevail among market participants. We build a theoretical model that highlights the mechanisms underlying the formation of market conventions. We then test this model empirically on the euro/dollar exchange rate between January 1995 and December 2008. We rely on two alternative methods : a macroeconomic analysis and an econometric analysis based on the estimation of a time varying parameter model. Both methods show that market switches between fundamentals considered in a bull convention and in a bear convention explain the euro/dollar dynamics between January 1995 and December 2008. Besides, at horizons longer than 1 month, the out-of-sample forecasting power of the convention model beats the traditional exchange rate models and the random walk.
Subjects / Keywords
Exchange Rate Dynamics; Convention Theory; Imperfect Knowledge Economics; Kalman filter; Genetic Algorithm
JEL
G10 - General
G12 - Asset Pricing; Trading Volume; Bond Interest Rates
F31 - Foreign Exchange

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