The Distribution of Exchange Rates in the EMS
AbstractExchange rates of currencies in the Exchange Rate Mechanism (ERM) of the European Monetary System (EMS) are characterized by long periods of stability interrupted by periods of extreme volatility. The periods of volatility appear at times of realignments of the central parities and at times when the exchange rate is within the ERM bands. We begin by considering a procedure for finding outliers based on measuring distance as a quadratic form. The evidence suggests that the exchange rates of the EMS can be described by a mixture of two distributions. We therefore model the exchange rate as switching between two distributions--one that holds in stable times and the other that holds in volatile times. In particular, we use Hamilton's Markov-switching model. In addition, we extend Hamilton's model by allowing the probability of switching from one state to another to depend on the position of the exchange rate within its EMS band. This model has the interesting implication that near the edge of the band, large movements--either realignments or large jumps to the centre of the band--are more likely if the move to the edge of the band has been precipitous. Copyright @ 1996 by John Wiley & Sons, Ltd. All rights reserved.
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Bibliographic InfoArticle provided by John Wiley & Sons, Ltd. in its journal International Journal of Finance & Economics.
Volume (Year): 1 (1996)
Issue (Month): 1 (January)
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Web page: http://www.interscience.wiley.com/jpages/1076-9307/
Other versions of this item:
- Charles Engel & Craig S. Hakkio, 1994. "The distribution of exchange rates in the EMS," Research Working Paper 94-03, Federal Reserve Bank of Kansas City.
- Charles Engel & Craig S. Hakkio, 1996. "The Distribution of Exchange Rates in the EMS," NBER Working Papers 4834, National Bureau of Economic Research, Inc.
- F3 - International Economics - - International Finance
- F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
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