Abstract: Since the magnitude of exchange rate overshooting may not be the same for different exchange rates of a currency, a monetary expansion or contraction in, for example, the EMU, will affect the exchange rate between the U.S. dollar and the yen, even though there are no changes in monetary fundamentals in the U.S. or Japan. This fact is demonstrated in a sticky-price monetary model due originally to Dornbusch (1976) that is enlarged with currency traders that use chartism in the form of moving averages. This result is interesting since, according to the empirical literature, there are often large movements in nominal exchange rates that are apparently unexplained by macroeconomic fundamentals.
Abstract: It is demonstrated that adaptive learning in the least squares sense may be incapable of satisfactorily reducing the number of attainable equilibria in a rational expectations model when focusing on the forward-solutions to the model. The model examined, as an illustration, is a basic asset pricing model for exchange rate determination that is augmented with technical trading in the currency market in the form of moving averages since it is the most commonly used technique according to questionnaire surveys. The forward-solutions to such a model are preferable to the backward-solutions that are normally utilized since announcement effects is an important feature in currency trade. Because of technical trading in foreign exchange, the current exchange rate depends on jmax lags of the exchange rate, meaning that the model has jmax+1 rational expectations equilibria, where several of them are adaptively learnable in the least squares sense. However, since past exchange rates should not affect the current exchange rate when technical trading is absent, it is possible to single out a unique equilibrium among the adaptively learnable equilibria that is economically meaningful. To put it differently, a rational expectations solution to the general model should have a rational expectations solution to a nested model as its limit, and it is our belief that the proposed continuity criterion is applicable in many heterogeneous agents models in economics and finance. It is worth noting that the model examined can also be viewed as a model for stock price determination in which the forward-solutions to the model are preferable to the backward-solutions since the importance of announcement effects is a common characteristic for currency and stock markets.
Abstract: The aim of this paper is to illustrate how the stability of a stochastic dynamic system is measured using the Lyapunov exponents. Specifically, we use a feedforward neural network to estimate these exponents as well as asymptotic results for this estimator to test for unstable (chaotic) dynamics. The data set used is spot electricity prices from the Nordic power exchange market, Nord Pool, and the dynamic system that generates these prices appears to be chaotic in one case since the null hypothesis of a non-positive largest Lyapunov exponent is rejected at the 1 per cent level.
Abstract: The purpose of this paper is to implement theoretically, the observation that the relative importance of fundamental versus technical analysis in the foreign exchange market depends on the time horizon in currency trade. For shorter time horizons, more weight is placed on technical analysis, while more weight is placed on fundamental analysis for longer horizons. The theoretical framework is the Dornbusch overshooting model, where moving averages is the technical trading technique used by the chartists. The perfect foresight path near long-run equilibrium is derived, and it is shown that the magnitude of exchange rate overshooting is larger than in the Dornbusch model. Specifically, the extent of overshooting depends inversely on the time horizon in currency trade. How changes in the model's structural parameters endogenously affect this time horizon and the magnitude of overshooting along the perfect foresight path are also derived.
Abstract: It is well known that cigarette smoking and the use of other addictive goods is harmful to health. Still, some people smoke cigarettes and drink alcohol in their daily lives. The consumption of addictive goods seems, therefore, to be the antithesis of rational behavior. In this article, however, it is demonstrated that a rational individual, in the sense that he or she maximizes his or her well-being while anticipating the future consequences of his or her choices, may in fact choose to consume addictive goods. Specifically, the two-good extension of the rational addiction model is demonstrated and related to relevant policy questions. For instance, should one encourage the use of smokeless tobacco in smoking cessation programs? According to the empirical results, the answer is no. Further, should one discourage smoking by increasing the tax on cigarettes? Again, the answer is no.
Abstract: How has the European monetary integration, with the creation of the EMU, affected the stability and volatility of foreign exchange? In order to answer this question, stability and volatility measures are defined and calculated. We then use these to investigate the changes in the stability and volatility of 16 European currencies, and in the volatility of the shocks to these currencies. The stability measures are based on smooth Lyapunov exponents, while the volatility measures utilize variances. The results indicate that when most of the currencies become more stable, a majority of them also become less volatile. For example, following the agreement of the Maastricht Treaty most currencies became more stable and less volatile, whereas they became less stable and more volatile when the Danish public voted against the treaty. Finally, there is no empirical support for the view that a decision to step aside from a closer monetary collaboration has a negative effect on the stability of the currency.
Abstract: When modelling demand for addictive consumption goods, the most widely used framework is the rational addiction model proposed by Becker and Murphy. This paper extends the rational addiction model to include two addictive consumption goods, alcohol and cigarettes, and using aggregate annual time series on sales volumes for the period 1955-1999, estimates the aggregate demand for these goods in Sweden, where OLS estimates are compared to GMM estimates allowing for possible endogeneity of lagged and lead consumption. First, the demand for alcohol and cigarettes are estimated as separate equations and it is found that alcohol demand is quite well described by the rational addiction model while the same is not true for cigarettes. The own-price elasticities are negative, and alcohol demand is more elastic than cigarette demand. The cross-price elasticities are also negative, showing that alcohol and cigarettes are complements. Since consumption of alcohol and cigarettes are probably simultaneous decisions, the demand for these goods is estimated as a system of equations and it is found that alcohol demand is still positively affected by lagged and lead consumption while cigarette demand is not. It is also found that the elasticities obtained are now generally smaller compared to when estimating the equations separately.
Abstract: The rational addiction model is often used in empirical analysis of demand for cigarettes. We propose an extension of the model to include both legal and bootleg cigarettes. Demand equations are estimated using a Swedish data set covering the aggregate markets for legal and bootleg cigarettes for the period 1964-2001. The results are quite mixed, but our model works well for describing both legal and bootleg cigarette demand when past and future consumption are treated as exogenous. Further, legal cigarette demand is negatively related to price, while bootleg cigarette demand is positively related to the legal price. The positive sign indicates, as expected, the drawback of using excise duty on legal cigarettes, which is that more agents are attracted into the market for bootleg cigarettes. When testing the hypothesis of a common habit stock for legal and bootleg cigarettes, it cannot be ruled out that they accumulate the same habit stock.
Abstract: The rational addiction model is often used for empirical analysis of the demand for addictive goods. We propose an extension of the model to include two goods, cigarettes and Swedish moist snuff, locally known as snus. Demand equations are estimated using aggregated annual time series data (in first differences) for the period 1964–1997. The findings from the dataset used give some support to the rational addiction hypothesis. The cross-price elasticities are negative, which indicates that taking snus contributes to increased smoking. Thus it is not advisable to encourage the use of the less harmful snus in smoking cessation programs.
Abstract: It is shown in this letter that the magnitude of exchange rate overshooting is larger than in Dornbusch (1976) when chartists are introduced into the model. Specifically, the extent of overshooting depends inversely on the planning horizon. The latter follows from explicitly modelling the behavior of practitioners: for shorter planning horizons, more weight is placed on technical analysis, while more weight is placed on fundamental analysis for longer planning horizons.
Abstract: I artikeln undersöker författarna hur den europeiska monetära integrationen har inverkat på stabiliteten och volatiliteten hos 16 europeiska valutor, däribland den svenska kronan. Eftersom värdet på en valuta kan börja fluktuera mer på grund av att chockerna till ekonomin har blivit större eller att ekonomin har blivit mindre stabil, så görs en tydlig åtskillnad mellan volatiliteten hos en valutas växelkurser och stabiliteten hos de dynamiska system som har genererat växelkurserna. En så kallad skvalpvaluta är därför en valuta vars viktigare växelkurser har blivit genererade av system som blivit väsentligen mindre stabila vid en viktig ekonomisk-politisk händelse, men som inte nödvändigtvis har fått mer volatila växelkurser. När det gäller viktiga händelser under 1990-talet och i början av 2000-talet, så framträder två tydliga resultat. Överenskommelsen om Maastrichtfördraget i december 1991 innebar att de flesta valutor blev mer stabila och mindre volatila, emedan de istället blev mindre stabila och mer volatila när danska folket röstade nej till fördraget i juni 1992. Dock är det svårt att finna belägg för påståendet att mindre länder som valt att stå utanför EMU, och då speciellt Sverige, skulle ha skvalpvalutor.
Abstract: In this paper, a statistical framework utilizing a blockwise bootstrap procedure is used to test for the presence of a positive Lyapunov exponent in Swedish exchange rates [M. Bask, R. Gençay, Physica D 114 (1998) 1]. This is done since a necessary condition for chaotic dynamics is a positive Lyapunov exponent. Daily data for the Swedish Krona against the Deutsche Mark, the ECU, the US Dollar and the Yen exchange rates are examined. In most cases, the null hypothesis that the Lyapunov exponent is zero is rejected in favor of a positive exponent.
Abstract: The purpose of this paper is to show how the stability properties of non-linear dynamic models may be characterized and studied, where the degree of stability is defined by the effects of exogenous shocks on the evolution of the observed stochastic system. This type of stability concept is frequently of interest in economics, e.g., in real business cycle theory.
We argue that smooth Lyapunov exponents can be used to measure the degree of stability of a stochastic dynamic model. It is emphasized that the stability properties of the model should be considered when the volatility of the variable modelled is of interest. When a parametric model is fitted to observed data, an estimator of the largest smooth Lyapunov exponent is presented which is consistent and asymptotically normal. The small sample properties of this estimator are examined in a Monte Carlo study. Finally, we illustrate how the presented framework can be used to study the degree of stability and the volatility of an exchange rate.
Abstract: Detecting the presence of deterministic chaos in economic time series is an important problem that may be solved by measuring the largest Lyapunov exponent. In this paper we present estimates of the largest Lyapunov exponent in daily data for the Swedish Krona vs Deutsche Mark, ECU, U.S. Dollar and Yen exchange rates. In order to estimate the dimension of the systems producing these exchange rate series, we also present estimates of the correlation dimension. We found indications of deterministic chaos in all exchange rate series. However, the estimates for the largest Lyapunov exponents are not reliable, except in the Swedish Krona-ECU case, because of the limited number of data points. In the Swedish Krona-ECU case, we found indications of a low-order chaotic dynamical system.
Abstract: We embed an expectations-based optimal policy rule into Gali and Monacelli’s [19] DSGE model for a small open economy that is augmented with trend following in currency trade to examine the prerequisites for monetary policy. We find that a unique REE that is least squares learnable often is the outcome when there is a limited amount of trend following, but that a less flexible inflation rate targeting may cause a multiplicity of REE. We also compute impulse-response functions for key variables to study how the economy returns to steady state after being hit by a shock.
Abstract: It is demonstrated that the exchange rate should be included in the Taylor rule when there is heterogeneity in currency trade to have a determinate and least squares learnable REE that is desirable in an inflation rate targeting regime. Moreover, for certain Taylor rule parametrizations, these properties of the rule are robust against the degree of technical trading in currency trade.
Abstract: The aim of this letter is to discuss and illustrate what we call (λ,σ²)-analysis, which is a method to distinguish between the stability of a stochastic dynamic system and the volatility of a variable generated by this system. It is also emphasized that this method is able to generate new research questions for economic theory. The data set used in an empirical illustration is spot electricity prices from Nord Pool.
Abstract: The aim of this paper is to answer the question whether one should respond to nominal exchange rate movements in monetary policy to have a desirable outcome in the economy. The theoretical framework is a small open DSGE economy that is closed by a Taylor rule for the monetary authority, and a determinate REE that is least squares learnable is defined as a desirable outcome in the economy. When the policy-rule contains contemporaneous data on the output gap and the CPI inflation rate, the monetary authority does not have to care about the exchange rate as long as there is enough with inertia in policy-making. In fact, due to a parity condition at the international asset market, interest rate smoothing and a response to the nominal exchange rate change are perfect substitutes in monetary policy. In other words, we give a rationale for the monetary authority to focus on the change in the nominal interest rate rather than its level in policy-making. Thus, we have a case for interest rate smoothing.
Abstract: It is shown that an optimal policy rule implemented as an expectations-based rule has desirable properties in a standard macroeconomic model extended with a cost channel for monetary disturbances and inflation rate expectations that partly are backward-looking. Specifically, optimal policy under commitment is associated with a determinate REE that is stable under learning, whereas under discretion, inflation rate targeting cannot be too flexible to have the same outcome.
Abstract: The difference between market risk and potential market risk is emphasized, where a measure of the latter risk is proposed. Specifically, it is argued that the spectrum of smooth Lyapunov exponents can be utilized in what we call (λ,σ²)-analysis, which is a method to monitor the aforementioned risk measures. The reason is that these exponents focus on the stability properties (λ) of the stochastic dynamic system generating asset returns, while more traditional risk measures such as value-at-risk are concerned with the distribution of returns (σ²).
Abstract: We incorporate technical trading into the monetary approach to exchange rates, and estimate the model for four Central and Eastern European countries (CEECs) that introduced the policy of free floating in the late 1990s; the Czech Republic, Hungary, Poland and Slovakia. We find that past exchange rates contribute significantly to the determination of the spot exchange rate. We also find a feedback behavior driving the exchange rate to its fundamental value although the mean reversion parameter is small. Overall, this means that these currency markets have developed a complex structure of different trader types, which already is documented for developed countries.
Abstract: We embed different instrument rules into Galà and Monacelli's (2005) new Keynesian model for a small open economy that is augmented with technical trading in currency trade to examine the prerequisites for monetary policy. Specifically, conditions for a determinate and least squares learnable REE are in focus. When a contemporaneous data specification of the rule is used in policy-making, the degree of trend following in currency trade does not affect these conditions, except in case of an extensive use of trend following, whereas a forward expectations specification makes it less likely to have a determinate and learnable REE when the degree of trend following is increasing. We allow for interest rate inertia in the analysis.
Abstract: A DSGE model with a Taylor rule is augmented with an evolutionary switching between technical and fundamental analyses in currency trade, where the fractions of these trading tools are determined within the model. Then, a shock is hitting this economy. As a result, chaotic dynamics and long swings may be present in the exchange rate, which are appealing features of the model due to earlier findings in the empirical literature.
Abstract: The purpose of this paper is to examine whether the common Nordic power market, Nord Pool, has been competitive or if suppliers of electric power have had market power. Specifically, because the evolution from national markets to a multi-national power market has taken place step by step, we examine how the degree of market power has evolved during this integration process. The theoretical framework is the Bresnahan [4]-Lau [15] method and the analysis is performed using weekly data for the period 1996 to 2004. The results show that suppliers of electricity have had small, but statistically significant, market power during this period, and that the degree of market power has been reduced as the Nord Pool area has expanded.
Abstract: An asset pricing model for exchange rate determination is presented, where technical analysis in currency trade is incorporated in the form of a moving average technique. As a result, the model has jmax+1 rational expectations equilibria (REE), where jmax is large, since jmax past exchange rates affect the current rate due to technical trading. There is, however, a unique REE that is economically relevant, and focusing on this REE, it is shown that the exchange rate is much more sensitive to a change in money supply than when technical analysis is absent in currency trade. This result is important since it sheds light on the so-called exchange rate disconnect puzzle in international finance.
