Fundamentals and Technical Trading: Behavior of Exchange Rates in the CEECs

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.

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:

$$s_{m,t+1}^{e}=\omega \left( \tau \right) E\left[ s_{t+1}\right] +\left( 1-\omega \left( \tau \right) \right) \left( s_{t}+\alpha \left( s_{t}-MA_{t}\right) \right) .$$

(A.1)

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

$$\begin{array}{rll}s_{m,t+1}^{e} &=&\left( 1-\exp \left( -\tau \right) \right) E\left[ s_{t+1} \right] +\exp \left( -\tau \right) \nonumber\\ &&\cdot \,\left( s_{t}+\alpha \left( s_{t}-\left( 1-\exp \left( -v\right) \right) \sum\limits_{j=0}^{\infty }\exp \left( -jv\right) s_{t-j}\right) \right) . \end{array}$$

(A.2)

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:

$$\begin{array}{rll}s_{t} &=&\frac{x_{1}+\beta _{0}x_{3}}{1-\beta _{1}x_{3}}\cdot \left( m_{t}-m_{t}^{\ast }-\gamma _{y}\left( y_{t}-y_{t}^{\ast }\right) \right) \nonumber \\ && +\, \frac{1}{1-\beta _{1}x_{3}}\cdot \sum\limits_{j=1}^{j_{\max }-1}\left( \beta _{j+1}x_{3}-x_{2}\exp \left( -jv\right) \right) s_{t-j} \nonumber \\ &&-\, \frac{x_{2}\exp \left( -j_{\max }v\right) }{1-\beta _{1}x_{3}}\cdot s_{t-j_{\max }}, \end{array}$$

(A.3)

where

$$m_{t}-m_{t}^{\ast }-\gamma _{y}\left( y_{t}-y_{t}^{\ast }\right) =m_{t-1}-m_{t-1}^{\ast }-\gamma _{y}\left( y_{t-1}-y_{t-1}^{\ast }\right)$$

(A.4)

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.□