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Exchange Rate Mean Reversion within a Target Zone: Evidence from a Country on the Periphery of the ERM

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Author Info

  • António Portugal Duarte

    ()
    (Faculdade de Economia/GEMF, Universidade de Coimbra)

  • João Sousa Andrade

    ()
    (Faculdade de Economia/GEMF, Universidade de Coimbra)

  • Adelaide Duarte

    ()
    (Faculdade de Economia/GEMF, Universidade de Coimbra)

Abstract

The aim of this study is to assess to what extent the Portuguese participation in the European Monetary System (EMS) has been characterized by mean reverting behaviour, as predicted by the exchange rate target zone model developed by Krugman (1991). For this purpose, a new class of mean reversion tests is introduced. The empirical analysis of mean reversion in the Portuguese exchange rate shows that most of the traditional unit root and stationarity tests point to the nonstationarity of the exchange rate within the band. However, using a set of variance-ratio tests, it was possible to detect the presence of a martingale difference sequence. This suggests that the Portuguese foreign exchange market has functioned efficiently, allowing us to conclude that the adoption of an exchange rate target zone regime has contributed decisively to the creation of the macroeconomic stability conditions necessary for the participation of Portugal in the euro area.

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Bibliographic Info

Paper provided by GEMF - Faculdade de Economia, Universidade de Coimbra in its series GEMF Working Papers with number 2009-15.

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Length: 39 pages
Date of creation: Nov 2009
Date of revision:
Handle: RePEc:gmf:wpaper:2009-15

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Keywords: difference sequence; mean reversion; stationarity; target zones and unit roots;

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References

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  1. Ken Froot & Kenneth Rogoff, . "Perspectives on PPP and Long-Run Real Exchange Rates," Working Paper 32027, Harvard University OpenScholar.
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  17. 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. António Portugal Duarte & João Sousa Andrade & Adelaide Duarte, 2010. "Exchange Rate Target Zones: A Survey of the Literature," GEMF Working Papers 2010-14, GEMF - Faculdade de Economia, Universidade de Coimbra.

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