Speculative bubbles in the foreign exchange markets.

Abstract

The study examines the existence, duration and size of speculative bubbles in the exchange rate markets. More in detail, we use various two-state regime-switching models to describe the dynamics in three different exchange rates, namely the British pound/US dollar exchange rate, the Canadian dollar/US dollar exchange rate and the Swiss franc/US dollar exchange rate. We also test the predictive ability of our models to detect “extreme” positive or negative movements in the aforementioned exchange rates. Our findings provide evidence supporting the existence of bubbles in the exchange rate markets. In some cases, our regime-switching models seem to predict extreme market movements.