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Exchange Rate Dynamics Under Stochastic Regime Shifts: A Unified Approach

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  • Froot, Kenneth
  • Obstfeld, Maurice

Abstract

Simple techniques of regulated Brownian motion are used to analyse the behaviour of the exchange rate when official policy reaction functions are subject to future stochastic changes. We examine exchange rate dynamics in cases where the authorities promise (i) to confine a floating rate within a predetermined range, (ii) to peg the currency once it reaches a predetermined future level, and (iii) to unify a system of dual exchange rates. Similarities between these and several related examples of regime switching are stressed. We also discuss how stochastic regime changes can affect some standard statistical tests of hypotheses about exchange rates.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 522.

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Date of creation: Feb 1991
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Handle: RePEc:cpr:ceprdp:522

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Keywords: Regime Change; Regulated Brownian Motion; Target Zone;

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  1. Krugman, Paul R, 1991. "Target Zones and Exchange Rate Dynamics," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 669-82, August.
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