Target Zone Interventions and Coordination of Expectations

Abstract

Foreign exchange markets regularly display severe bubbles. This paper explores whether or not so-called target zone interventions are an effective tool for central banks to stabilize the exchange rate. We define such intervention operations as buying/selling an undervalued/overvalued currency when the distance between the exchange rate and its fundamental value exceeds a critical threshold value. On the basis of a non-linear empirical exchange rate model with chartists and fundamentalists, we find that target zone interventions not only have the power to reduce misalignments but also earn profits. Keywords

Empirical Validation of Agent-Based Models ✶ ✶We gratefully acknowledge the very detailed and careful comments by three anonymous reviewers. Very useful feedback and comments have also been provided by Robert Axtell, Herbert Dawid, Cees Diks, and Blake LeBaron.

“…2 The most widely applied configuration is the model with a market maker in terms of price changes or returns (see e.g. Frankel and Froot, 1990;Reitz and Westerhoff, 2003;Reitz et al, 2006;Manzan and Westerhoff, 2007;De Jong et al, 2009, 2010Zwinkels, 2014, 2015). The empirical models are typically of the form:…”

“…Apart from making some strong assumptions about agent behavior, this method identifies the time-varying impact of agent groups, but does not identify the drivers of this time-variation. Reitz and Westerhoff (2003) and Reitz et al (2006) estimate a model of chartists and fundamentalists for exchange rates by assuming the weight of technical traders to be constant, and the weight of fundamental traders to depend on the normalized misalignment between the market and fundamental price. As such, there is no formal switching between forecasting rules, but the impact of fundamentalists is time-varying.…”

Empirical Validation of Agent-Based Models

“…Explaining foreign exchange market dynamics has long been an important motivation for the early HAM literature, which is also reflected in the amount of empirical work on this asset class; see Vigfusson (1997), Gilli and Winker (2003), Reitz and Westerhoff (2003), Ahrens and Reitz (2005), Reitz et al (2006), Manzan and Westerhoff (2007), De Jong et al (2010), Kouwenberg et al (2017). The issue with such extremely liquid financial markets, though, is to find expectation formation rules that hold empirically as it is hard to find empirical patterns in such near-efficient markets.…”

Computationally intelligent agents in economics and finance

“…Certainly, not all agent-based econometric models are network-based. There are a series of agent-based financial econometric models which do not explicitly refer to a network or a graph [43,33,53]. 15 Ref.…”