Uncertainty Aversion in an Agent-Based Model of Foreign Exchange Rate Formation

In this paper we test whether investors are uncertainty averse during a real-life trading process in the foreign exchange market. We do this through an agent-based model in which fundamentalist and chartist beliefs of the exchange rate are allowed to be either uncertainty neutral or uncertainty averse. The uncertainty aversion is modelled via the maxmin expected utility approach. We find that traders are uncertainty averse in the FX market. The estimation results show that the inclusion of uncertainty averse agents improves the performance of the model and the uncertainty aversion parameter is significantly different from zero. Fundamentalists are found to be uncertainty neutral and chartists - mainly uncertainty averse