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Chaos in the Dornbusch Model of the Exchange Rate

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  2. Economics, Finance, Business & Management
  3. Credit and Capital Markets – Kredit und Kapital
  4. Vol. 25, Issue 1
  5. pp. 26–54

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De Grauwe, P., Dewachter, H. Chaos in the Dornbusch Model of the Exchange Rate. Credit and Capital Markets – Kredit und Kapital, 25(1), 26-54. https://doi.org/10.3790/ccm.25.1.26
De Grauwe, Paul and Dewachter, Hans "Chaos in the Dornbusch Model of the Exchange Rate" Credit and Capital Markets – Kredit und Kapital 25.1, 1992, 26-54. https://doi.org/10.3790/ccm.25.1.26
De Grauwe, Paul/Dewachter, Hans (1992): Chaos in the Dornbusch Model of the Exchange Rate, in: Credit and Capital Markets – Kredit und Kapital, vol. 25, iss. 1, 26-54, [online] https://doi.org/10.3790/ccm.25.1.26
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Chaos in the Dornbusch Model of the Exchange Rate

De Grauwe, Paul | Dewachter, Hans

Credit and Capital Markets – Kredit und Kapital, Vol. 25 (1992), Iss. 1 : pp. 26–54

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Article Details

Publisher Name
Duncker & Humblot
DOI
https://doi.org/10.3790/ccm.25.1.26
Language
Multiple languages
Pages
29

Author Details

Paul De Grauwe, Leuven

Hans Dewachter, Leuven

References

  1. Allen, H. and Taylor, M.: Charts, Noise and Fundamentals: A Study of the London Foreign Exchange market, CEPR Discussion Paper, no. 341, Sept. 1989.  Google Scholar
  2. Cutler, D., Poterba, J. and Summers, L.: Speculative Dynamics, NBER Working Paper, No. 3242, January 1990.  Google Scholar
  3. De Grauwe, P., and Vansanten, K.: Deterministic Chaos in the Foreign Exchange Market, CEPR Discussion Paper, No. 370, January 1990.  Google Scholar
  4. Delong, B., Shleifer, A., Summers, L., Waldmann: Noise Trader Risk in Financial Markets, Journal of Finance, 1990.  Google Scholar
  5. Devaney, R.: An Introduction to Chaotic Dynamical Systems, Addison Wesley Company, Second Edition, Menlo Park, 1989, pp. 60-68.  Google Scholar
  6. Dornbusch, R.: Expectations and Exchange rate Dynamics, Journal of Political Economy 84, pp.1161 - 1176, 1976.  Google Scholar
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  8. Frankel, J.: Chartists, Fundamentalists and Trading in the Foreign Exchange Market, NBER Reporter, winter 1989/90, 9 - 12.  Google Scholar
  9. Frenkel, J. and Mussa, M.: Asset Markets, Exchange Rates and the Balance of Payments, in Jones, Ronald W. and Kenen, Peter B., eds., Handbook of International Economics Vol. II, Amsterdam, North-Holland, 1985.  Google Scholar
  10. Goodhart, C.: News and the Foreign Exchange Market, LSE Financial Market Group, Discussion Paper No. 71, January 1990.  Google Scholar
  11. Levich, R.: Empirical Studies of Exchange Rates: Price Behaviour, Rate Determination and Market Efficiency, Handbook of International Economics, vol II, Jones R. and Kenen P., Elsevier Science Publishers, 1985.  Google Scholar
  12. Meese, R. and Rogoff, K.: Empirical Exchange Rate Models of the Seventies: Do They Fit Out-of-Sample?, Journal of International Economics, 1983, 3 - 24.  Google Scholar
  13. Mussa, M.: The Theory of Exchange Rate Determination, in Bilson, John F. O. and Marston, Richard C., eds., Exchange Rate Theory and Practice, Chicago: University of Chicago Press, 1984, pp. 13 - 78.  Google Scholar
  14. Scheinkman, J. and Lebaron, B.: Nonlinear Dynamics and Stock Returns, Journal of Business vol. 62 no. 3 (1989).  Google Scholar
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  16. Allen, H. and Taylor, M.: Charts, Noise and Fundamentals: A Study of the London Foreign Exchange market, CEPR Discussion Paper, no. 341, Sept. 1989.  Google Scholar
  17. Cutler, D., Poterba, J. and Summers, L.: Speculative Dynamics, NBER Working Paper, No. 3242, January 1990.  Google Scholar
  18. De Grauwe, P., and Vansanten, K.: Deterministic Chaos in the Foreign Exchange Market, CEPR Discussion Paper, No. 370, January 1990.  Google Scholar
  19. Delong, B., Shleifer, A., Summers, L., Waldmann: Noise Trader Risk in Financial Markets, Journal of Finance, 1990.  Google Scholar
  20. Devaney, R.: An Introduction to Chaotic Dynamical Systems, Addison Wesley Company, Second Edition, Menlo Park, 1989, pp. 60-68.  Google Scholar
  21. Dornbusch, R.: Expectations and Exchange rate Dynamics, Journal of Political Economy 84, pp.1161 – 1176, 1976.  Google Scholar
  22. Frankel, J. and Froot: The Dollar as a Speculative Bubble: A Tale of Chartists and Fundamentalists, NBER Working Paper, No.1854, March 1986.  Google Scholar
  23. Frankel, J.: Chartists, Fundamentalists and Trading in the Foreign Exchange Market, NBER Reporter, winter 1989/90, 9 – 12.  Google Scholar
  24. Frenkel, J. and Mussa, M.: Asset Markets, Exchange Rates and the Balance of Payments, in Jones, Ronald W. and Kenen, Peter B., eds., Handbook of International Economics Vol. II, Amsterdam, North-Holland, 1985.  Google Scholar
  25. Goodhart, C.: News and the Foreign Exchange Market, LSE Financial Market Group, Discussion Paper No. 71, January 1990.  Google Scholar
  26. Levich, R.: Empirical Studies of Exchange Rates: Price Behaviour, Rate Determination and Market Efficiency, Handbook of International Economics, vol II, Jones R. and Kenen P., Elsevier Science Publishers, 1985.  Google Scholar
  27. Meese, R. and Rogoff, K.: Empirical Exchange Rate Models of the Seventies: Do They Fit Out-of-Sample?, Journal of International Economics, 1983, 3 – 24.  Google Scholar
  28. Mussa, M.: The Theory of Exchange Rate Determination, in Bilson, John F. O. and Marston, Richard C., eds., Exchange Rate Theory and Practice, Chicago: University of Chicago Press, 1984, pp. 13 – 78.  Google Scholar
  29. Scheinkman, J. and Lebaron, B.: Nonlinear Dynamics and Stock Returns, Journal of Business vol. 62 no. 3 (1989).  Google Scholar
  30. Shiller, R.: Stock Prices and Social Dynamics, Brooking Papers on Economic Activity, 1984, No. 2, 457 – 98.  Google Scholar

Abstract

Chaos in the Dornbusch Model of the Exchange Rate

In this paper a model of the exchange rate is presented. The model incorporates interactions between different classes of agents. We consider two classes: fundamentalists who use PPP to forecast future exchange rates and chartists, using simple moving average schemes. Moreover we allow the relative strength of these two classes to change over time. Imposing a specific functional form for the relative strength we obtain a closed form solution for the model. The main conclusion of the paper is that these interactions can lead to chaotic paths of the exchange rates. This source of instability is independent of any arrival of news and can explain the recent findings of exchange rate movements that cannot be attributed to new information.

Table of Contents

Section Title Page Action Price
Paul De Grauwe/Hans Dewachter: Chaos in the Dornbusch Model\rof the Exchange Rate 26
I. Introduction 26
II. The Model 27
1. The Dornbusch Model 27
a) The Money Market Equilibrium Condition 27
b) The Open Interest Parity Condition 27
c) Goods Market Equilibrium 28
2. The Speculative Dynamics 28
3. Solution of the Model 32
III. Existence of Chaos 33
IV. Effects of Money Supply Changes 40
V. The Role of News in the Exchange Rate Dynamics 42
VI. Some Preliminary Empirical Tests 45
VII. Chaos in the Price Level and in the Interest Rate 47
VIII. Conclusion 49
Appendix 50
References 52
Summary: Chaos in the Dornbusch Model of the Exchange Rate 53
Zusammenfassung: Chaos im Dornbusch-Modell für den Wechselkurs 53
Résumé: Chaos dans le modèle du cours du change de Dornbusch 54

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