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Marc Lavoie, Gauthier Daigle (2011) A behavioural finance model of exchange rate expectations within a stock-flow consistent framework”, Metroeconomica, vol. 62, n. 3, pp. 434-458

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Abstract: The paper combines behavioural finance to a stock-flow consistent model of a two-country economy in the portfolio tradition, with imperfect asset substitutability.
‘Fondamentalists’ and ‘chartists’ set their expectations of changes in exchange rates based on some assessed fundamental value and past trends respectively. We find that exchange rate expectations have a significant effect on exchange rate movements and trade account balances during the traverse and in steady states. A flexible exchange rate regime will continue to provide stabilizing properties, as long as the proportion of chartist actors relative to fundamentalist agents is not overly large. However, if chartists dominate fundamentalists, any shock will provoke cyclical changes of ever greater magnitude.

Keywords: behavioural finance, exchange rates, instability, persistence, portfolio choice

November 13, 2010 | Comments Closed