Title: Regime shifts in currency markets with bounded rationality and limits to arbitrage
Authors: Soumya Datta - South Asian University (India) [presenting]
Abstract: The purpose is to examine the impact of limits to arbitrage in currency markets with heterogeneous boundedly rational agents, under both complete and incomplete information. Departing from existing literature, we show that limits to arbitrage become more restrictive for larger deviation from the fundamentals. This leads to multiple equilibria. Under complete information, either everyone or no one attempts arbitrage. Under incomplete information, however, there might be a continuum of agents attempting arbitrage. In this case, a regime shift between fundamental and non-fundamental steady states is possible. We also find that the prior beliefs are not important in case of small noises and uniform priors; however, for larger noises and nonuniform priors, prior beliefs might acquire a greater role. In this case, in a departure from efficient markets, large fund managers might have a disproportionately large power in influencing the outcome.