Nonlinear Dynamics in Expectations: An Empirical Study

Abstract

The paper investigates whether expectations data are consistent with nonlinear dynamics possibly involving deterministic chaos. Survey data on exchange rate expectations for four different currencies over one-week and one-month prediction horizons are considered. The evidence indicates that one cannot neglect the possibility of nonlinear dynamics underlying the erratic behaviour of expectation data, even though the evidence in that respect is not overwhelming. I. INTRODUCTIOǸChaos' has become a familiar word in economics, encompassing different patterns of nonlinear behaviour. The concept of deterministic chaos indicates, for example, the possibility of simple nonlinear difference equations or systems of differential equations which generate apparently erratic behaviour in spite of a deterministic underlying model. More precisely, Brown (1995) outlines three fundamental characteristics of chaos: (a) irregular periodicity; (b) sensitivity to initial conditions, and (c) a lack of predictability. The aforementioned characteristics can appear in different theoretical settings, for example, in the context of growth theory (e.g. Bernhabib, 1996). General surveys appear in Frank 167 Instituto de Economia, Universidade Federal do Rio de Janeiro à The author acknowledges Swarna Dutt and Dipak Ghosh for kindly providing the dataset used in the present paper. Comments from an anonymous referee were useful in improving the presentation of the paper. The usual caveats apply.