Heterogeneity of Agents and Exchange Rate Dynamics: Evidence from the EMS

We develop and estimate a dynamic heterogeneous agent model for the EMS period. Our empirical results suggest that the existence of heterogeneous interacting agents is indeed a possible explanation for the dynamics of exchange rates during the EMS; we find strong evidence in favor of our model using in- and out-of-sample tests. Moreover, we show that the heterogeneous agent model outperforms the random walk in out-of-sample forecasting in all country/period combinations. Finally, we study the dynamic limit properties of the estimated non-linear system