Abstract

System Dynamics of Chaotic Foreign-Exchange Markets

Studies on chaos as a reason for non-linear foreign-exchange rate movements have hitherto focused on empirical aspects, for the most part, neglecting the question as to why chaos has come about and how this phenomenon can be explained. In search for a plausible explanation, the present paper understands the foreignexchange market to be an open and dissipative system as distinct from a closed conserative one as assumed under traditional models. The analysis for which a system-theoretical approach has been adopted because of the complexity of the assumed interrelationships is based on different groups of market participants. Banks, non-banks and central banks operate on the market in different ways in pursuit of different objectives and through different types of transaction. However, differences exist not only in respect of market participants’ behaviour, but also in respect of the manner in which they collect and process information. Expectations are formed on the basis of different information based on fundamental analyses and on chart analyses depending on the type of transaction and the time horizon. The resultant reactions influence, in some form or other, the modes of behaviour of all market participants and have thus implications for their own decision-making. The answer to the question as to how market participants interact and how their reactions fit together depends on whether foreign-exchange markets are in a state of chaos or not.