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Exchange Rate Monitoring Bands: Theory and Policy

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  • Luisa Corrado

    (University of Cambridge)

  • Marcus Miller

    (University of Warwick)

  • Lei Zhang

    (University of Warwick)

Abstract

Recent empirical research by Mark Taylor and coauthors has found evidence of hybrid dynamics for the real exchange rate. While there is a random walk near equilibrium, for real exchange rates some distance from equilibrium there is mean-reversion which increases with the degree of misalignment. An interesting question is whether this nonlinear mean-reversion is policy-induced. John Williamson (1998) for example, has proposed a "monitoring band" in which there is no intervention near equilibrium but there is substantial intervention triggered by exchange rate deviations outside a preset band. In this paper we develop a theoretical model for a stylised monitoring band to see whether it can generate patterns of nonlinear mean-reversion akin to those reported in empirical research

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Bibliographic Info

Paper provided by Money Macro and Finance Research Group in its series Money Macro and Finance (MMF) Research Group Conference 2006 with number 146.

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Date of creation: 02 Feb 2007
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Handle: RePEc:mmf:mmfc06:146

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Web page: http://www.essex.ac.uk/afm/mmf/index.html

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Keywords: Monitoring Band; Non-linear Mean-Reversion; Near Random Walk Dynamics;

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References

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  1. Giuseppe Bertola & Lars E.O. Svensson, 1991. "Stochastic Devaluation Risk and the Empirical Fit of Target Zone Models," NBER Working Papers 3576, National Bureau of Economic Research, Inc.
  2. Mark P. Taylor, 1995. "The Economics of Exchange Rates," Journal of Economic Literature, American Economic Association, vol. 33(1), pages 13-47, March.
  3. Peel, David & Sarno, Lucio & Taylor, Mark P, 2001. "Nonlinear Mean-Reversion in Real Exchange Rates: Towards a Solution to the Purchasing Power Parity Puzzles," CEPR Discussion Papers 2658, C.E.P.R. Discussion Papers.
  4. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
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  7. Lars E. O. Svensson, 1992. "An Interpretation of Recent Research on Exchange Rate Target Zones," Journal of Economic Perspectives, American Economic Association, vol. 6(4), pages 119-144, Fall.
  8. Kilian, Lutz & Taylor, Mark P., 2003. "Why is it so difficult to beat the random walk forecast of exchange rates?," Journal of International Economics, Elsevier, vol. 60(1), pages 85-107, May.
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  10. John Williamson, 1999. "Crawling Bands or Monitoring Bands: How to Manage Exchange Rates in a World of Capital Mobility," Policy Briefs PB99-03, Peterson Institute for International Economics.
  11. Miller, Marcus & Weller, Paul, 1991. "Exchange Rate Bands with Price Inertia," Economic Journal, Royal Economic Society, vol. 101(409), pages 1380-99, November.
  12. Dumas, Bernard, 1992. "Dynamic Equilibrium and the Real Exchange Rate in a Spatially Separated World," Review of Financial Studies, Society for Financial Studies, vol. 5(2), pages 153-80.
  13. Morris, Stephen & Shin, Hyun Song, 1998. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks," American Economic Review, American Economic Association, vol. 88(3), pages 587-97, June.
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  15. Lindbecg, H. Soderlind, P., 1992. "Target Zone Models and the Intervention Policy; The Swedish Case," Papers 496, Stockholm - International Economic Studies.
  16. Taylor, Mark P. & Allen, Helen, 1992. "The use of technical analysis in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 11(3), pages 304-314, June.
  17. Kenneth A. Froot & Maurice Obstfeld, 1989. "Intrinsic Bubbles: The Case of Stock Prices," NBER Working Papers 3091, National Bureau of Economic Research, Inc.
  18. Andrés VELASCO, 2000. "Exchange-Rate Policies For Developing Countries: What Have We Learned? What Do We Still Not Know?," G-24 Discussion Papers 5, United Nations Conference on Trade and Development.
  19. Lothian, James R & Taylor, Mark P, 1996. "Real Exchange Rate Behavior: The Recent Float from the Perspective of the Past Two Centuries," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 488-509, June.
  20. Sarno, Lucio & Taylor, Mark P, 2001. "Official Intervention in the Foreign Exchange Market: Is It Effective, and, If So, How Does It Work?," CEPR Discussion Papers 2690, C.E.P.R. Discussion Papers.
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  23. Frankel, Jeffrey A & Froot, Kenneth A, 1986. "Understanding the U.S. Dollar in the Eighties: The Expectations of Chartists and Fundamentalists," The Economic Record, The Economic Society of Australia, vol. 0(0), pages 24-38, Supplemen.
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Citations

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Cited by:
  1. Gilles DUFRENOT & Elisabeth GRIMAUD & Eug=E9nie LATIL & Val=E9rie MIGNON, 2003. "Real exhange rate misalignment in Hungary: a fractionally integrated=20 threshold model," Econometrics 0309001, EconWPA.
  2. G. Dufrenot & E. Grimaud & E. Latil & V. Mignon, 2003. "Real exchange rate misalignment in Hungary: a fractionally integrated threshold model," THEMA Working Papers 2003-07, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
  3. Luisa Corrado & Marcus Miller & Lei Zhang, 2007. "Bulls, bears and excess volatility: can currency intervention help?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 12(2), pages 261-272.

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