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
TypeCommunication / Conférence
Conference title28th GdRE Annual International Symposium on Money, Banking and Finance
MetadataShow full item record
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 / KeywordsExchange Rate Dynamics; Convention Theory; Imperfect Knowledge Economics; Kalman filter; Genetic Algorithm
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