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Target Zones and Forward Rates in a Model with Repeated Realignments

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Author Info

  • Gordon M. Bodnar
  • Leonardo Bartolini

Abstract

This paper studies the implications of the imperfect credibility of an exchange rate target zone on the term structure of forward premia. The relationship between spot and forward exchange rates of different maturities reflects the possibility of repeated realignments of the exchange rate band. The credibility of the commitment to the target zone implicit in forward market data can be extracted by estimating the model. Application to French/German data indicates that the model is capable of matching observed patterns of interest rate differentials during the EMS, while yielding estimates of the credibility parameters that accord with the experience of the FF/DM exchange rate during the 1980s.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 92/22.

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Length: 54
Date of creation: 01 Mar 1992
Date of revision:
Handle: RePEc:imf:imfwpa:92/22

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Related research

Keywords: Target zones; Exchange rate realignments; Economic models; exchange rate; exchange rates; probability; spot exchange rate; spot exchange rates; probabilities; equation; forward exchange; exchange rate band; samples; covariance; exchange rate target; correlation; forward exchange rate; standard errors; forward exchange rates; exchange rate target zones; computation; exchange rate dynamics; exchange rate bands; statistic; statistics; equations; probability density; exchange rate targets; adjustment parameter; exchange rate data; linear models; regression equation; standard deviation; exchange rate target zone; current exchange rate; autocorrelation; exchange rate determination; foreign exchange; optimization; frequency distributions; floating exchange rates; nominal exchange rate; linear regression; probability density function; diffusion process; home currency; rate of change; lagrange multiplier tests; exchange risk; statistical models; exchange markets; estimation procedure; parameter vector; freely floating exchange rates; exchange rate positions; foreign exchange risk; integral; fourier series; difference equation; fortran program; empirical model; significance levels; foreign exchange markets; poisson process; probability distribution; survey; linear model; exchange rate management;

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Citations

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Cited by:
  1. Antoine Magnier, 1992. "Théorie des zones cibles et fonctionnement du SME," Économie et Prévision, Programme National Persée, Programme National Persée, vol. 104(3), pages 87-113.
  2. Bartolini, Leonardo & Giorgianni, Lorenzo, 2001. "Excess Volatility of Exchange Rates with Unobservable Fundamentals," Review of International Economics, Wiley Blackwell, Wiley Blackwell, vol. 9(3), pages 518-30, August.
  3. Hans Lindberg & Lars E.O. Svensson & Paul Soderlind, 1991. "Devaluation Expectations: The Swedish Krona 1982-1991," NBER Working Papers 3918, National Bureau of Economic Research, Inc.
  4. Andrew K. Rose & Lars E.O. Svensson, 1991. "Expected and Predicted Realignments: The FF/DM Exchange Rate During the EMS," NBER Working Papers 3685, National Bureau of Economic Research, Inc.
  5. Garber, Peter M. & Svensson, Lars E.O., 1995. "The operation and collapse of fixed exchange rate regimes," Handbook of International Economics, Elsevier, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 36, pages 1865-1911 Elsevier.
  6. Leonardo Bartolini & Alessandro Prati, 1998. "Soft exchange rate bands and speculative attacks: theory and evidence from the ERM since August 1993," Staff Reports, Federal Reserve Bank of New York 43, Federal Reserve Bank of New York.
  7. Geert Bekaert & Stephen F. Gray, 1999. "Target Zones and Exchange Rates: An Empirical Investigation," NBER Working Papers 5445, National Bureau of Economic Research, Inc.
  8. Schmukler, Sergio L. & Serven, Luis, 2002. "Pricing currency risk : facts and puzzles from currency boards," Policy Research Working Paper Series 2815, The World Bank.
  9. Dai, Meixing, 1998. "Les effets stabilisants de la zone-cible du taux d’inflation
    [The stabilising effects of inflation-targeting zone]
    ," MPRA Paper 13856, University Library of Munich, Germany, revised Nov 2001.
  10. Elias Belessakos & Michael Papaioannou, 1996. "Simple credibility tests of the ERM bands for the pound sterling and the Italian lira," Open Economies Review, Springer, Springer, vol. 7(3), pages 219-236, July.
  11. Svensson, Lars E. O., 1993. "Assessing target zone credibility : Mean reversion and devaluation expectations in the ERM, 1979-1992," European Economic Review, Elsevier, Elsevier, vol. 37(4), pages 763-793, May.
  12. Pierre Siklos & Rod Tarajos, 1996. "Fundamentals and devaluation expectations in target zones: Some new evidence from the ERM," Open Economies Review, Springer, Springer, vol. 7(1), pages 35-59, January.
  13. Schmukler, Sergio L. & Serven, Luis, 2002. "Pricing currency risk under currency boards," Journal of Development Economics, Elsevier, Elsevier, vol. 69(2), pages 367-391, December.

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