Chartist trading in exchange rate theory

University dissertation from Umeå : Umeå universitet, Institutionen för Nationalekonomi

Abstract: This thesis consists of four papers, of which paper 1 and 4 are co-written with Mikael Bask. Paper [1] implements chartists trading in a sticky-price monetary model for determining the exchange rate. It is demonstrated that chartists cause the exchange rate to "overshoot the overshooting equilibrium" of a sticky-price monetary model. Chartists base their trading on a short-long moving average. The importance of technical trading depends inversely on the time horizon in currency trade. The exchange rate's perfect foresight path near long-run equilibrium is derived and it is demonstrated that the shorter the time horizon, the greater the exchange rate overshooting.The aim of Paper [2] is to see how the dynamics of the basic target zone model changes when chartists and fundamentalists are introduced. Chartists use technical trading and the relative importance of technical and fundamental analyses depend on the time horizon in currency trade. The model also includes realignment expectations, which increase with the weight of chartists. The introduction of chartists may significantly reduce and reverse, the so-called "honeymoon effect" of a fully credible target zone. Further, chartists may cause the correlation between the exchange rate and the instantaneous interest rate differential to become either positive or negative.Using a chartist-fundamentalist set-up, Paper [3] derives the effects on the current exchange rate of central bank intervention. Fundamentalists have rational expectations and chartists use so called support and resistance levels in their trading. This technique results in chartists having both bandwagon expectations and regressive expectations. Chartists may enhance or suppress the effect of intervention depending on their expectations. The results indicate that a chartist channel exists.The aim of Paper [4] is threefold; (i) to investigate if there is a unique rational expectations equilibrium (REE) in a new Keynesian macroeconomic model augmented with technical trading, (ii), to investigate if the unique REE is adaptively learnable and, (iii), to investigate if this unique and adaptively learnable REE is desirable in an inflation rate targeting regime. The monetary authority is using a Taylor rule when setting the interest rate. A main conclusion is that a robust Taylor rule implies that the monetary authority should increase (decrease) the interest rate when the CPI inflation rate increases (decreases) and when the currency gets stronger (weaker).