Abstract
This paper seeks to empirically determine whether feedback trading strategies result in stabilization or destabilization in the foreign exchange market and if such strategies are a distinctive characteristic of an emerging economy or they are a common element to both developed and emerging economies. These hypotheses are tested via the use of a feedback model augmented with a generalized autoregressive conditional heteroskedasticity (GARCH) process for modeling the errors. The results suggest presence of both positive and negative feedback trading and asymmetric behavior in both types of economies. Irrespective of the nature of feedback trading, presence of asymmetric behavior implies that market traders rely on central banks to intervene so they can realize short-term profits. Finally, in cases of a positive first-order autoregressive parameter presence of the bandwagon effect is implied, whereby past currency movements are followed by expectations of currency movements in the same direction.
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Notes
It can be noted here that it may well be the case that may not be the central bank that causes the unexpected outcomes but rather some unknown private sector participant(s). This point was raised by a referee.
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The author is indebted to a referee whose criticisms greatly improved the focus and flow of the paper and the journal’s finance editor, Richard M. Robinson. The usual disclaimer applies. This paper has benefited from a 2002 research grant from the Dolan School of Business, Fairfield University.
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Laopodis, N.T. Noise trading and autocorrelation interactions in the foreign exchange market: Evidence from developed and emerging economies. J Econ Finan 32, 271–293 (2008). https://doi.org/10.1007/s12197-007-9018-y
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DOI: https://doi.org/10.1007/s12197-007-9018-y