An econometric diffusion model of exchange rate movements within a band : implications for interest rate differential and credibility of exchange rate policy
AbstractThe paper presents a model ofexchange rate movements within a specified exchange rate band enforced by central bank interventions. The model is based on the empirical observation that the exchange rate has usually been strictly inside the band, at least in Finland. In this model the distribution of the exchange rate is truncated lognormal from the edges towards the center of the band and hence quite different from the bimodal distribution of the standard target zone model. The model is estimated using the daily observations of the changes in the FIM exchange rate since 1987. The estimated model is used to compute the expected future values of the FIM/ECU rate within the band for the period June 7, 1991- September 7, 1992 and the corresponding interest rate differential between Finland and EMS countries. Subtracting this from the actual interest rate differential gives a measure of expected devaluation and devaluation risk premium. The premium was very large in autumn 1991 before the devaluation in November but afterwards it decreased considerably. After a few months the devaluation pressure increased again and finally on September 8, 1992 markka was allowed to float.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoArticle provided by Finnish Economic Association in its journal Finnish Economic Papers.
Volume (Year): 5 (1992)
Issue (Month): 2 (Autumn)
Find related papers by JEL classification:
- F3 - International Economics - - International Finance
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Svensson, Lars E O, 1991.
"The Term Structure of Interest Rate Differentials in a Target Zone: Theory and Swedish Data,"
CEPR Discussion Papers
495, C.E.P.R. Discussion Papers.
- Svensson, Lars E. O., 1991. "The term structure of interest rate differentials in a target zone : Theory and Swedish data," Journal of Monetary Economics, Elsevier, vol. 28(1), pages 87-116, August.
- Lars E.O. Svensson, 1991. "The Term Structure of Interest Rate Differentials in a Target Zone: Theory and Swedish Data," NBER Working Papers 3374, National Bureau of Economic Research, Inc.
- Svensson, L.E.O., 1990. "The Term Structure of Interest Rate Differentials in a Target Zone: Theory and Swedish Data," Papers 466, Stockholm - International Economic Studies.
- Pikkarainen, Pentti, 1991. "International portfolio diversification: the basket-peg regime," Journal of International Money and Finance, Elsevier, vol. 10(3), pages 432-442, September.
- Lars E. O. Svensson, 1991. "Assessing Target Zone Credibility," IMF Working Papers 91/96, International Monetary Fund.
- Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
- Lars E. O. Svensson, 1991.
"The Simplest Test of Target Zone Credibility,"
IMF Staff Papers,
Palgrave Macmillan, vol. 38(3), pages 655-665, September.
- Svensson, L.E.O., 1990. "The Simplest Test of Target Zone Credibility," Papers 469, Stockholm - International Economic Studies.
- Lars E.O. Svensson, 1992. "The Simplest Test of Target Zone Credibility," NBER Working Papers 3394, National Bureau of Economic Research, Inc.
- Svensson, Lars E O, 1991. "The Simplest Test of Target Zone Credibility," CEPR Discussion Papers 493, C.E.P.R. Discussion Papers.
- Zhaohui Chen & Alberto Giovannini, 1992. "Estimating Expected Exchange Rates Under Target Zones," NBER Working Papers 3955, National Bureau of Economic Research, Inc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Editorial Secretary).
If references are entirely missing, you can add them using this form.