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Exchange Rate Target Zone Models: A Bayesian Evaluation

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  • Li, Kai
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Abstract

This paper develops a Bayesian approach to estimating exchange rate target zone models and rational expectations models in general. It also introduces a simultaneous-equation target zone model that incorporates stochastic realignment risk. Using FF/DM and IL/DM exchange rate data, we find that the signing of the 1987 Basle-Nyborg Agreement reduces both the magnitude and the likelihood of a central parity realignment, while the lagged exchange rate deviation from its central parity increases them. Furthermore, the interest rate policies and the monetary conditions of the participating countries signal a forthcoming realignment. In general, we are unable to improve upon a simple random walk model in out-of-sample exchange rate prediction by introducing target zone models.

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File URL: http://qed.econ.queensu.ca:80/jae/1999-v14.5/
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Article provided by John Wiley & Sons, Ltd. in its journal Journal of Applied Econometrics.

Volume (Year): 14 (1999)
Issue (Month): 5 (Sept.-Oct.)
Pages: 461-90

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Handle: RePEc:jae:japmet:v:14:y:1999:i:5:p:461-90

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Cited by:
  1. Oleg Korenok & Stanislav Radchenko, 2005. "The smooth transition autoregressive target zone model with the Gaussian stochastic volatility and TGARCH error terms with applications," Working Papers 0505, VCU School of Business, Department of Economics.
  2. Chakravarty, Sugato & Li, Kai, 2003. "A Bayesian analysis of dual trader informativeness in futures markets," Journal of Empirical Finance, Elsevier, vol. 10(3), pages 355-371, May.
  3. Oleg Korenok & Stanislav Radchenko, 2005. "Expectations Anchoring in Inflation Targeting Regimes," Working Papers 0503, VCU School of Business, Department of Economics.
  4. Rangvid, Jesper & Sorensen, Carsten, 2001. "Determinants of the implied shadow exchange rates from a target zone," European Economic Review, Elsevier, vol. 45(9), pages 1665-1696, October.

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