A Quasi-Bounded Target Zone Model - Theory and Application to Hong Kong Dollar
AbstractThe exchange rate target zone literature has often suggested that mean reversion in an exchange rate within a zone can be taken as evidence that the system is credible. While the exchange rate system in Hong Kong is perceived as having a high degree of credibility, there is mixed empirical evidence to suggest that the HKD shows mean reversion. This paper proposes a quasi-bounded process for exchange rate dynamics within a target zone, consistent with a fully credible exchange rate band in which the exchange rate cannot breach the strong-side limit while the weak-side limit is only accessible under restricted conditions of the relationship between the parameters of the drift term and stochastic part of the process. Our empirical results suggest that this model can describe the dynamics of the Hong Kong dollar where the drifting force is an increasing function of foreign reserves.
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Bibliographic InfoPaper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 282012.
Length: 25 pages
Date of creation: Nov 2012
Date of revision:
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Stochastics Process; Target Zone; Bounded Process;
Find related papers by JEL classification:
- F31 - International Economics - - International Finance - - - Foreign Exchange
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
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