Evolution of Beliefs, Volatility of Exchange Rates and Market Experiments

This research project develops a model of foreign exchange markets in which agents’ expectations are explicitly modeled and evolve over time and examines how these models perform in terms of capturing the behavior observed in the experiments with human subjects.

Expectations are an essential factor in understanding macroeconomic dynamics. It is now widely accepted that the effects of government policies depend critically upon the way in which policy affects expectations, and so the design of a policy strategy requires a well-founded view of the way that expectations are likely to be affected by alternative policies. Expectations are also an especially important factor in the dynamics of financial markets. Much modern analysis models expectations by assuming ‘rational expectations’; that is, it is assumed that the expectations of economic agents will correspond to those of the modeler, without inquiring into the process that brings about this correspondence. But for some purposes it is desirable to look more closely at the process through which expectations are formed, rather than simply hypothesizing such a correspondence. This research provides a novel approach to modeling the evolution of heterogeneous beliefs and expectations in a multi-country environment and includes linkages between the dynamics of foreign exchange markets, the behavior of financial intermediaries, and government policies.