Behavioral Heterogeneity and Excessive Volatility of RMB Exchange Rate

The paper develops a two-type behavioral heterogeneous agent model including fundamentalists and chartists. It examines whether investors’ behavioral heterogeneity is related to the excessive volatility of RMB exchange rate. We use the deviation of the real exchange rate from the fundamental exchange rate as a measure of excessive exchange rate volatility. The fundamental value is calculated by the revised RMB fundamental exchange rate model with cointegration technology. After estimating the behavioral heterogeneous agent model using the monthly RMB exchange rate data from October 2006 to November 2020, we find that the heterogeneity of traders in price and trading strategies can significantly explain excess volatility of the RMB exchange rate. Our analysis of two significant fluctuations in 2015-2016 and 2018-2019 further corroborates our key finding that investors’ behavioral heterogeneity plays an important role in explaining excess volatility of RMB exchange rate.