Stochastic Simulation of the Exchange Rate

Abstract

The rational expectations paradigm, that dominates macroeconomics fails to take into account the complexity of the information, which is so vast that the individual brain cannot understand the full of it. The agents are boundedly rational, so they use simple forecasting rules that do not incorporate all available information, but they are willing to learn and will switch to other rules if it turns out that these rules are more profitable than the rule they have been using. Such trial and error learning strategies create the dynamics in the foreign exchange market, with two types of equilibria, a fundamental and a non-fundamental equilibrium to which the exchange rate is attracted.