Heterogeneous Expectations, Currency Options and the euro/dollar exchange rate

An exchange rate model with heterogeneous expectations is developed in which agents are subject to mutual mimetic contagion in their portfolio decisions. Two alternative sources of heterogeneity are tested in order to explain the short-term dynamics of the euro/dollar since January 1999. Information conveyed by over-the-counter currency options allows the time-varying proportions of each category of agents to be inferred, as well as their respective exchange rate expectations and standard deviations. The proportion of optimistic agents in the evolution of the euro and the proportion of confident agents in their exchange rate anticipations induce portfolio reallocations, which generate euro/dollar forecasts.