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Non-Linear Exchange Rate Dynamics in Target Zones: A Bumpy Road towards a Honeymoon - Some Evidence from the ERM, ERM2 and Selected New EU Member States

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  • Jesús Crespo-Cuaresma
  • Balázs Egert
  • Ronald MacDonald

Abstract

This study investigates exchange rate movements in the Exchange Rate Mechanism (ERM) of the European Monetary System (EMS) and in the Exchange Rate Mechanism II (ERM-II). On the basis of the variant of the target zone model proposed by Bartolini and Prati (1999) and Bessec (2003), we set up a three-regime self-exciting threshold autoregressive model (SETAR) with a non-stationary central band and explicit modelling of the conditional variance. This modelling framework is employed to model daily DM-based and median currency-based bilateral exchange rates of countries participating in the original ERM and also for exchange rates of the Czech Republic, Hungary, Poland and Slovakia from 1999 to 2004. Our results confirm the presence of strong non-linearities and asymmetries in the ERM period, which, however, seem to differ across countries and diminish during the last stage of the run-up to the euro. Important non-linear adjustments are also detected for Denmark in ERM-2 and for our group of four CEE economies.

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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 1511.

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Date of creation: 2005
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Handle: RePEc:ces:ceswps:_1511

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Keywords: target zone; ERM; non-linearity; SETAR;

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  1. Lundbergh, Stefan & Teräsvirta, Timo, 2003. "A time series model for an exchange rate in a target zone with applications," Working Paper Series in Economics and Finance 533, Stockholm School of Economics.
  2. Tristani, Oreste, 1994. " Variable Probability of Realignment in a Target Zone," Scandinavian Journal of Economics, Wiley Blackwell, vol. 96(1), pages 1-14.
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  6. Chung, Chae-Shick & Tauchen, George, 2001. "Testing Target-Zone Models Using Efficient Method of Moments," Journal of Business & Economic Statistics, American Statistical Association, vol. 19(3), pages 255-69, July.
  7. Andrews, Donald W K & Ploberger, Werner, 1994. "Optimal Tests When a Nuisance Parameter Is Present Only under the Alternative," Econometrica, Econometric Society, vol. 62(6), pages 1383-1414, November.
  8. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
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  12. Anthony, Myrvin & MacDonald, Ronald, 1999. "The width of the band and exchange rate mean-reversion: some further ERM-based results," Journal of International Money and Finance, Elsevier, vol. 18(3), pages 411-428.
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Cited by:
  1. Lucjan Orlowski & Krzyzstof Rybinski, 2005. "Implications of ERM2 for Poland’s Monetary Policy," William Davidson Institute Working Papers Series wp802, William Davidson Institute at the University of Michigan.
  2. Jesús Rodríguez López & Hugo Rodríguez Mendizábal, 2006. "The optimal degree of exchange rate flexibility: A target zone approach," Working Papers 06.22, Universidad Pablo de Olavide, Department of Economics.
  3. Miller, J. Isaac, 2011. "Testing the bounds: Empirical behavior of target zone fundamentals," Economic Modelling, Elsevier, vol. 28(4), pages 1782-1792, July.

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