Exchange rate dynamics under state-contingent stochastic process switching
AbstractThis paper offers a closed-form solution of a process switching problem, i.e., switching the exchange rate regime from free-floating to a completely fixed one. An example of such regime change is the adoption of the Euro. In contrast to previous studies on the subject, this paper analyzes a specific case when foreign exchange market participants consider both the Euro locking rate and locking date as uncertain. Preceding the locking, the exchange rate is determined by three factors: fundamental, market expectations for the Euro locking rate, and date. The model is used to examine the conditions under which the exchange rate volatility is mitigated by the prospect of locking.
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Bibliographic InfoArticle provided by Elsevier in its journal Journal of International Money and Finance.
Volume (Year): 30 (2011)
Issue (Month): 5 (September)
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Web page: http://www.elsevier.com/locate/inca/30443
Stochastic process switching Eurozone entry Exchange rate stabilization;
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