Exchange rate expectations: controlled experiments with artificial traders

The purpose of this paper is to investigate the plausibility of standard exchange rate expectations mechanisms, which are favored over rational expectations in survey data for longer horizons, in an artificial economy with heterogeneous traders. Adaptive expectations markets, bandwagon expectations markets and distributed lag expectations markets exhibit more serial correlation than found in empirical quarterly data. Extrapolative expectations markets often do not, but generate too many extreme returns to be empirically plausible. Regressive expectations markets are able to reproduce the stylized facts of empirical quarterly exchange rates, confirming the importance of fundamentals, in particular in dampening the frequency of extreme exchange rate returns.