## Abstract

We incorporate technical trading into the monetary approach to exchange rates, and estimate the model for four Central and Eastern European countries 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.

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## Notes

A detailed description of the empirical analysis is available on request from the authors that also includes results discussed in the paper but not found in the tables.

No adjustment is made after the accession of Slovenia to the euro area in January 2007. However, since the size of Slovenia’s economy in relation to the other economies in the euro area is very small, this error should be negligible.

The unit root test in levels includes an intercept and a trend, while the test in first differences includes only an intercept.

We extend the estimation specifications by dummies for special events including the EU membership of the new member states (from May 2004 to the end of sample) and the period of changeover from national currencies to the euro (January 1999 to December 2001). The specification for the Czech Republic also includes dummies for the currency crisis in May and June 1997, and the specifications for Hungary and Poland also include dummies for the periods of inflation rate targeting (from June 2001 and January 2002, respectively, to the end of sample). Finally, the specification for Slovakia also includes dummies for the pre-reform period between January 1993 and October 1998, and the change of the ERM II parity in March 2007. However, we have to keep in mind that the critical values of the cointegration test are not valid if dummy variables are included.

As an alternative to the asymptotic critical values, we also used finite-sample critical values according to Cheung and Lai (1993). The results have remained unchanged. Further problems could be caused by heteroscedasticity of exchange rates. Nevertheless, Wong et al. (2005) argue that conditional heteroscedasticity is likely to be weak if cointegration exists, which is confirmed by our tests.

There is an alternative interpretation of

*θ*: Instead of assuming that agents using fundamental analysis have rational expectations, assume that the time horizon in currency trading is determined by rational expectations and that agents using fundamental analysis believe that the exchange rate will return to its fundamental value. As before, agents using technical analysis use a moving average technique in currency trading. In such a model,*θ*would be a measure of the adjustment speed of the exchange rate to its fundamental value. See Bask (2007) for a time-continuous model with these characteristics.The relevant dummies include the period of inflation targeting in Hungary and Poland, and the change of the ERM II parity in Slovakia in March 2007 (see footnote 4).

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We are grateful to Elina Rainio for helpful assistance with data and to two anonymous referees for helpful comments and suggestions. The usual disclaimer applies.

## Appendix: Proofs

### Appendix: Proofs

### Proof of Lemma 1

First, expectations formed by fundamental analysis and chartism in Eqs. 3–4 are substituted into market expectations in Eq. 1:

Second, substitute the weight function in Eq. 2 and the long-period moving average in Eq. 5 into Eq. A.1:

Finally, substitute Eq. A.2 into the baseline model in Eq. 11, solve for the current exchange rate, and the proof is completed.□

### Proof of Proposition 2

Given the solution in Eq. 15, determine the next time period’s exchange rate, substitute this exchange rate into the expectational difference equation in Eq. 13, and solve the resulting equation for the current exchange rate:

where

has been utilized in the derivation. That is, it is assumed that the fundamentals are constant over time. Then, the equation system for the parameters \(\left\{ \beta _{j}\right\} _{j=0}^{j_{\max }}\) in Eq. 16 is derived by comparing the parameters in Eq. 15 with those in Eq. A.3, and the proof is completed.□

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Bask, M., Fidrmuc, J. Fundamentals and Technical Trading: Behavior of Exchange Rates in the CEECs.
*Open Econ Rev* **20**, 589–605 (2009). https://doi.org/10.1007/s11079-008-9095-3

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DOI: https://doi.org/10.1007/s11079-008-9095-3