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An empirical reassessment of target-zone nonlinearities

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  • Garratt, Anthony
  • Psaradakis, Zacharias
  • Sola, Martin

Abstract

This paper investigates the presence of target-zone nonlinearities in the Pound Sterling/Deutsche Mark exchange rate for the period of the UK European Exchange Rate Mechanism (ERM) membership, using data with frequency of every two days. Tests against general nonlinear specifications as well as specifications consistent with a stochastic devaluation risk model of exchange rate target zones are carried out using recursive techniques. In addition, the significance of nonlinear effects is analysed within a recursive Bayesian frame-work. The authors find evidence of target-zone nonlinearities in the whole sample, but the recursive analysis yields support for the presence of such nonlinearities only in specific subsamples. The results imply that the reductions in the UK inflation was most likely a consequence of contractionary policies rather than of the expectational effects of the target zone.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 20 (2001)
Issue (Month): 4 (August)
Pages: 533-548

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Handle: RePEc:eee:jimfin:v:20:y:2001:i:4:p:533-548

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Web page: http://www.elsevier.com/locate/inca/30443

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References

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  1. Bertola, Giuseppe & Svensson, Lars E O, 1993. "Stochastic Devaluation Risk and the Empirical Fit of Target-Zone Models," Review of Economic Studies, Wiley Blackwell, vol. 60(3), pages 689-712, July.
  2. Robert P. Flood & Andrew K. Rose & Donald J. Mathieson, 1990. "An Empirical Exploration of Exchange Rate Target-Zones," NBER Working Papers 3543, National Bureau of Economic Research, Inc.
  3. Paul R. Krugman, 1988. "Target Zones and Exchange Rate Dynamics," NBER Working Papers 2481, National Bureau of Economic Research, Inc.
  4. Donald W.K. Andrews & Werner Ploberger, 1992. "Optimal Tests When a Nuisance Parameter Is Present Only Under the Alternative," Cowles Foundation Discussion Papers 1015, Cowles Foundation for Research in Economics, Yale University.
  5. Froot, Kenneth A. & Obstfeld, Maurice, 1991. "Exchange-rate dynamics under stochastic regime shifts : A unified approach," Journal of International Economics, Elsevier, vol. 31(3-4), pages 203-229, November.
  6. Donald W.K. Andrews, 1990. "Tests for Parameter Instability and Structural Change with Unknown Change Point," Cowles Foundation Discussion Papers 943, Cowles Foundation for Research in Economics, Yale University.
  7. Richard A. Meese & Andrew K. Rose, 1989. "An empirical assessment of non-linearities in models of exchange rate determination," International Finance Discussion Papers 367, Board of Governors of the Federal Reserve System (U.S.).
  8. Andrews, Donald W K & Monahan, J Christopher, 1992. "An Improved Heteroskedasticity and Autocorrelation Consistent Covariance Matrix Estimator," Econometrica, Econometric Society, vol. 60(4), pages 953-66, July.
  9. Francis X. Diebold & James M. Nason, 1989. "Nonparametric exchange rate prediction?," Finance and Economics Discussion Series 81, Board of Governors of the Federal Reserve System (U.S.).
  10. Fitzenberger, Bernd, 1998. "The moving blocks bootstrap and robust inference for linear least squares and quantile regressions," Journal of Econometrics, Elsevier, vol. 82(2), pages 235-287, February.
  11. Lars E. O. Svensson, 1992. "An Interpretation of Recent Research on Exchange Rate Target Zones," Journal of Economic Perspectives, American Economic Association, vol. 6(4), pages 119-144, Fall.
  12. Meese, Richard A & Rose, Andrew K, 1990. "Nonlinear, Nonparametric, Nonessential Exchange Rate Estimation," American Economic Review, American Economic Association, vol. 80(2), pages 192-96, May.
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Cited by:
  1. Venus Khim-Sen Liew & Kian-Ping Lim & Evan Lau & Chee-Keong Choong, 2003. "Exchange Rate – Relative Price Relationship: Nonlinear Evidence from Malaysia," International Finance 0312001, EconWPA.
  2. repec:ebl:ecbull:v:6:y:2005:i:11:p:1-16 is not listed on IDEAS
  3. Venus Khim-Sen Liew & Chee-Keong Choong & Evan Lau & Kian-Ping Lim, 2005. "Exchange Rate – Relative Price Nonlinear Cointegration Relationship in Malaysia," Economics Bulletin, AccessEcon, vol. 6(11), pages 1-16.

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