Animal spirits in the foreign exchange market

It is traditionally assumed in finance models that the fundamental value of an asset is known with certainty. In this paper we depart from that assumption. We propose a simple model of the exchange rate in which agents have biased and unbiased beliefs about the fundamental rate. We show that such a model produces waves of optimism and pessimism unrelated to the underlying fundamental value. In addition, the model shows that in a world characterized by the existence of heterogeneous beliefs about the fundamental, exchange rate movements can be remarkably complex even if only fundamentalist traders operate in the market.