Exchange Rate Mean Reversion within a Target Zone: Evidence from a Country on the Periphery of the ERM
AbstractThe 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 InfoPaper provided by GEMF - Faculdade de Economia, Universidade de Coimbra in its series GEMF Working Papers with number 2009-15.
Length: 39 pages
Date of creation: Nov 2009
Date of revision:
difference sequence; mean reversion; stationarity; target zones and unit roots;
Find related papers by JEL classification:
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
- C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
- F31 - International Economics - - International Finance - - - Foreign Exchange
- F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-11-21 (All new papers)
- NEP-CBA-2009-11-21 (Central Banking)
- NEP-IFN-2009-11-21 (International Finance)
- NEP-MON-2009-11-21 (Monetary Economics)
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