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Estimating Credibility In Colombia'S Exchange Rate Target Zone

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Arturo José Galindo ()

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Abstract

This paper analyzes credibility in the Colombian exchange rate target zone. A model of imperfect credibility, in the spirit of Bertola and Svensson (1993) is derived, and is used to explain why the exchange rate in Colombia has remained for prolonged periods neathe borders of the zone. The main feature of the model is that central parity depreciation expectations are endogenous with respect to the position of the exchange rate inside the target zone. The Krugman (1991) perfectly credible setup turns out to be a particular case of this general model. One of the main impliations of the model is that depreciation expectations increase rather than decrease as the exchange rate approaches the upper band. Hence a model as the one presented in this paper, is useful to explain the recent dynamics of interest rates in Colombia. It is also shown, that this model shares empirical feactures with the basic target zone model. Hence, policy makers might be misled when trying to recognize their credibility stance. A structural estimation of the underlying parameters of the model, using McFadden's (1989) method of simulated moments, is suggestedto identify the presence of non credibility issues. Econometric evidence suggest that Colombia's exchange rate target zone is properly described by a model of this nature.

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Paper provided by BANCO DE LA REPÚBLICA in its series BORRADORES DE ECONOMIA with number 002604.

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Length: 31
Date of creation: 30 Sep 1998
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Handle: RePEc:col:000094:002604

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  1. Newey, Whitney K & West, Kenneth D, 1987. "A Simple, Positive Semi-definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix," Econometrica, Econometric Society, vol. 55(3), pages 703-08, May. [Downloadable!] (restricted)
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  2. Cukierman, A. & Kiguel, M.A. & Leiderman, L., 1993. "The Choice of Exchange Rate Bands: Balancing Credibility and Flexibility," Papers 1-93, Tel Aviv - the Sackler Institute of Economic Studies.
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  3. Bertola, Giuseppe & Svensson, Lars E O, 1993. "Stochastic Devaluation Risk and the Empirical Fit of Target-Zone Models," Review of Economic Studies, Blackwell Publishing, vol. 60(3), pages 689-712, July. [Downloadable!] (restricted)
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  4. Krugman, Paul R, 1991. "Target Zones and Exchange Rate Dynamics," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 669-82, August. [Downloadable!] (restricted)
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  5. de Jong, F, 1994. "A Univariate Analysis of EMS Exchange Rates Using a Target Zone Model," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 9(1), pages 31-45, Jan.-Marc. [Downloadable!] (restricted)
  6. Lee, Bong-Soo & Ingram, Beth Fisher, 1991. "Simulation estimation of time-series models," Journal of Econometrics, Elsevier, vol. 47(2-3), pages 197-205, February. [Downloadable!] (restricted)
  7. Svensson, Lars E. O., 1991. "Target zones and interest rate variability," Journal of International Economics, Elsevier, vol. 31(1-2), pages 27-54, August. [Downloadable!] (restricted)
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  8. Chinn, Menzie D. & Meese, Richard A., 1995. "Banking on currency forecasts: How predictable is change in money?," Journal of International Economics, Elsevier, vol. 38(1-2), pages 161-178, February. [Downloadable!] (restricted)
  9. Richard Meese & Kenneth Rogoff, 1983. "The Out-of-Sample Failure of Empirical Exchange Rate Models: Sampling Error or Misspecification?," NBER Chapters, in: Exchange Rates and International Macroeconomics, pages 67-112 National Bureau of Economic Research, Inc. [Downloadable!]
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  10. Garber, P.M. & Svensson, L.E.O., 1994. "The Operation and Collapse of Fixed Exchange Rate Regimes," Papers 588, Stockholm - International Economic Studies.
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  11. Mizrach, Bruce, 1995. "Target zone models with stochastic realignments: an econometric evaluation," Journal of International Money and Finance, Elsevier, vol. 14(5), pages 641-657, October. [Downloadable!] (restricted)
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  12. Andrew K. Rose & Lars E.O. Svensson, 1995. "Expected and Predicted Realignments: The FF/DM Exchange Rate During the EMS," NBER Working Papers 3685, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  13. Geert Bekaert & Stephen F. Gray, 1999. "Target Zones and Exchange Rates: An Empirical Investigation," NBER Working Papers 5445, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  14. Robert P. Flood & Donald J. Mathieson & Andrew K. Rose, 1991. "An Empirical Exploration of Exchange Rate Target-Zones," IMF Working Papers 91/15, International Monetary Fund.
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  15. Lindberg, Hans & Soderlind, Paul, 1994. " Intervention Policy and Mean Reversion in Exchange Rate Target Zones: The Swedish Case," Scandinavian Journal of Economics, Blackwell Publishing, vol. 96(4), pages 499-513.
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