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Solving Stochastic Saddlepoint Systems: A Qualitative Treatment with Economic Applications

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  • Miller, Marcus
  • Weller, Paul

Abstract

We examine the effect of introducing stochastic shocks into a linear rational expectations model with saddlepoint dynamics generated by a forward looking asset price. We derive the fundamental differential equation governing the path of the asset price as a function of the 'sluggish' variable. The equation does not admit of closed form solutions in general, but we provide a complete qualitative characterization of the solution paths which are symmetric about equilibrium. The first application analyzes how financial markets might react to the implementation of fiscal stabilization policy where public expenditures are only adjusted when GNP moves outside a threshold around a target level. The second application examines exchange rate behavior in the presence of a currency subject to a known realignment rule requiring an adjustment to monetary polic.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 308.

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Date of creation: Apr 1989
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Handle: RePEc:cpr:ceprdp:308

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Related research

Keywords: Asset Prices; Dynamic Model; Expectations; Linear Model; Stochastic Shocks;

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Cited by:
  1. Paul Krugman & Julio Rotemberg, 1990. "Target Zones with Limited Reserves," NBER Working Papers 3418, National Bureau of Economic Research, Inc.
  2. Buiter, Willem H & Pesenti, Paolo, 1990. "Rational Speculative Bubbles in an Exchange Rate Target Zone," CEPR Discussion Papers 479, C.E.P.R. Discussion Papers.
  3. Lars E.O. Svensson, 1989. "Target Zones and Interest Rate Variability," NBER Working Papers 3218, National Bureau of Economic Research, Inc.
  4. Kempa, Bernd & Nelles, Michael & Pierdzioch, Christian, 1999. "The term structure of interest rates in a sticky-price target zone model," Journal of International Money and Finance, Elsevier, vol. 18(5), pages 817-834, October.
  5. Flood, Robert P & Garber, Peter M, 1991. "The Linkage between Speculative Attack and Target Zone Models of Exchange Rates," The Quarterly Journal of Economics, MIT Press, vol. 106(4), pages 1367-72, November.
  6. Barry Eichengreen & Peter Garber, 1990. "Before the Accord: U.S. Monetary-Financial Policy 1945-51," NBER Working Papers 3380, National Bureau of Economic Research, Inc.
  7. Oppers, S.E., 1993. "A Model of the Bimetallic System," Working Papers 332, Research Seminar in International Economics, University of Michigan.
  8. Beetsma, R.M.W.J. & Ploeg, F. van der, 1993. "Intramarginal interventions, bands and the pattern of EMS exchange rate distributions," Discussion Paper 1993-48, Tilburg University, Center for Economic Research.
  9. Beetsma, R.M.W.J. & Ploeg, F. van der, 1994. "Macroeconomic stabilisation and intervention policy under an exchange rate band," Discussion Paper 1994-27, Tilburg University, Center for Economic Research.
  10. Bernd Kempa & Michael Nelles, 1999. "Misalignments of real exchange rates and the credibility of nominal currency bands," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 135(4), pages 613-628, December.
  11. Kempa, Bernd & Nelles, Michael & Pierdzioch, Christian, 1997. "An analytical approximation of target zone exchange rate functions: the technique of collocation," Economics Letters, Elsevier, vol. 57(3), pages 339-343, December.

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