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The Determinants of Realignment Expectations Under the EMS: Some Empirical Regularities

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  • Zhaohui Chen
  • Alberto Giovannini
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    Abstract

    The stability of the EMS depends crucially on realignment expectations of the market participants. In this paper we discuss how to measure such expectations and how to relate them to economic fundamentals, central bank reputation, and institutional arrangements of the EMS. We find the following empirical regularities for FF/DM and IL/DM exchange rates: (1) expected devaluations are positively related to the current exchange rate deviation from the central parity; (2) expected devaluations are negatively related to the length of time since last realignment in the short and medium run; (3) the Basle-Nyborg agreements seem to have a stabilizing effect for both currencies examined, albeit through different channels; (4) large revaluation expectations occur immediately after devaluations. (1) and (4) are not inconsistent with the hypothesis of over-speculation or market inefficiency.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4291.

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    Date of creation: Mar 1993
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    Publication status: published as European Economic Review, Vol. 41, no. 9 (December 1997): 1687-1707.
    Handle: RePEc:nbr:nberwo:4291

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    1. Lars E. O. Svensson, 1991. "Assessing Target Zone Credibility," IMF Working Papers 91/96, International Monetary Fund.
    2. Robert P. Flood & Peter Isard, 1990. "Monetary Policy Strategies: A Correction: Reply to Lohmann," IMF Staff Papers, Palgrave Macmillan, vol. 37(2), pages 446-448, June.
    3. Lars E.O. Svensson, 1990. "The Foreign Exchange Risk Premium in a Target Zone with Devaluation Risk," NBER Working Papers 3466, National Bureau of Economic Research, Inc.
    4. Guillermo A. Calvo, 1983. "Trying to Stabilize: Some Theoretical Reflections Based on the Case of Argentina," NBER Chapters, in: Financial Policies and the World Capital Market: The Problem of Latin American Countries, pages 199-220 National Bureau of Economic Research, Inc.
    5. Lizondo, Jose Saul, 1983. "Foreign exchange futures prices under fixed exchange rates," Journal of International Economics, Elsevier, Elsevier, vol. 14(1-2), pages 69-84, February.
    6. Svensson, Lars E O, 1991. "Assessing Target Zone Credibility: Mean Reversion and Devaluation Expectations in the EMS," CEPR Discussion Papers, C.E.P.R. Discussion Papers 580, C.E.P.R. Discussion Papers.
    7. Flood, Robert P. & Garber, Peter M., 1984. "Collapsing exchange-rate regimes : Some linear examples," Journal of International Economics, Elsevier, Elsevier, vol. 17(1-2), pages 1-13, August.
    8. Pedro Aspe Armella & Rudiger Dornbusch & Maurice Obstfeld, 1983. "Financial Policies and the World Capital Market: The Problem of Latin American Countries," NBER Books, National Bureau of Economic Research, Inc, number arme83-1, October.
    9. Robert P. Flood & Peter Isard, 1988. "Monetary Policy Strategies," NBER Working Papers 2770, National Bureau of Economic Research, Inc.
    10. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 91(4), pages 589-610, August.
    11. Dornbusch, Rudiger, 1982. "Stabilization policies in developing countries: What have we learned?," World Development, Elsevier, Elsevier, vol. 10(9), pages 701-708, September.
    12. Susanne Lohmann, 1990. "Monetary Policy Strategies: A Correction: Comment on Flood and Isard," IMF Staff Papers, Palgrave Macmillan, vol. 37(2), pages 440-445, June.
    13. Zhaohui Chen & Alberto Giovannini, 1992. "Estimating Expected Exchange Rates Under Target Zones," NBER Working Papers 3955, National Bureau of Economic Research, Inc.
    14. Alberto Giovannini, 1990. "European Monetary Reform: Progress and Prospects," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 21(2), pages 217-292.
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    Cited by:
    1. 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.
    2. Hali J. Edison & Linda S. Kole, 1994. "European monetary arrangements: implications for the dollar, exchange rate variability and credibility," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 468, Board of Governors of the Federal Reserve System (U.S.).
    3. Peria, Maria Soledad Martinez, 1999. "A regime - switching approach to studying speculative attacks : focus on European Monetary System crises," Policy Research Working Paper Series 2132, The World Bank.
    4. Eva Gutierrez, 1996. "A model of realignment in the EMS," Investigaciones Economicas, Fundación SEPI, Fundación SEPI, vol. 20(2), pages 161-176, May.
    5. Ozkan, F. Gulcin, 2003. "Explaining ERM realignments: Insights from optimising models of currency crises," Journal of Macroeconomics, Elsevier, Elsevier, vol. 25(4), pages 491-507, December.
    6. Mundaca, Gabriela, 2003. "A Drift of the "Drift Adjustment Method"," Memorandum, Oslo University, Department of Economics 16/2002, Oslo University, Department of Economics.
    7. Antoine Magnier & Benoît Cœuré, 1996. "Crédibilité et fondamentaux macro-économiques au sein du SME : un examen empirique," Économie et Prévision, Programme National Persée, Programme National Persée, vol. 123(2), pages 113-146.
    8. Raul A. Feliz & John H. Welch, 1993. "The credibility and performance of unilateral target zones: a comparison of the Mexican and Chilean cases," Research Paper, Federal Reserve Bank of Dallas 9331, Federal Reserve Bank of Dallas.
    9. Peter J G Vlaar & Franz C Palm, 1993. "Inflation Differentials and Excess Returns in the European Monetary System," CEPR Financial Markets Paper, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 77 Bastwick Street, London EC1V 3PZ 0038, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 77 Bastwick Street, London EC1V 3PZ.
    10. Selma Mahfouz & Richard Hemming & Michael Kell, 2002. "The Effectiveness of Fiscal Policy in Stimulating Economic Activity," IMF Working Papers 02/208, International Monetary Fund.
    11. Cecilia Jona-Lasinio, 1999. "Le Franc français et la récente crise monétaire européenne," Économie et Prévision, Programme National Persée, Programme National Persée, vol. 140(4), pages 147-159.

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