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Stochastic Regime Switching and Stabilizing Policies within Regimes

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  • Karen K. Lewis
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    Abstract

    This paper describes a class of stochastic stabilizing policies within asset price regimes that can be easily incorporated into the framework of regime switching recently proposed by Froot and Obstfeld (1991). In contrast to previous treatments of market-driven fundamentals within the regime, authorities stochastically counteract movements in these fundamentals before asset prices reach boundary points. The paper describes how the stabilizing intra-regime intervention policies can be used to characterize the behavior of monetary authorities before fixing an exchange rate, as in the case studied by Flood and Garber (1983). An intervention policy within target zone bands consistent with empirical evidence is also a member of this class of policies. Furthermore, the stylized features of these intervention policies may be matched to actual data in a natural way.

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    File URL: http://www.nber.org/papers/w5289.pdf
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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5289.

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    Date of creation: Oct 1995
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    Publication status: published as International Journal of Finance and Economics, April 1996, vol.1, pp.71-86
    Handle: RePEc:nbr:nberwo:5289

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    1. Paul R. Krugman, 1988. "Target Zones and Exchange Rate Dynamics," NBER Working Papers 2481, National Bureau of Economic Research, Inc.
    2. Robert P. Flood & Peter M. Garber, 1981. "A Model of Stochastic Process Switching," NBER Working Papers 0626, National Bureau of Economic Research, Inc.
    3. Mussa, Michael, 1982. "A Model of Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 90(1), pages 74-104, February.
    4. Robert P. Flood & Peter M. Garber, 1989. "The Linkage Between Speculative Attack and Target Zone Models of Exchange Rates," NBER Working Papers 2918, National Bureau of Economic Research, Inc.
    5. Bertola, Giuseppe & Svensson, Lars E O, 1993. "Stochastic Devaluation Risk and the Empirical Fit of Target-Zone Models," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 60(3), pages 689-712, July.
    6. Bertola, G. & Cabarello, R.J., 1990. "Target Zones And Realignments," Discussion Papers, Columbia University, Department of Economics 1990_51, Columbia University, Department of Economics.
    7. Robert P. Flood & Andrew K. Rose & Donald J. Mathieson, 1990. "An Empirical Exploration of Exchange Rate Target-Zones," NBER Working Papers 3543, National Bureau of Economic Research, Inc.
    8. Svensson, L.E.O., 1989. "Target Zones And Interest Rate Variability," Papers, Stockholm - International Economic Studies 457, Stockholm - International Economic Studies.
    9. Nelson, Daniel B., 1990. "ARCH models as diffusion approximations," Journal of Econometrics, Elsevier, Elsevier, vol. 45(1-2), pages 7-38.
    10. Paul Krugman & Marcus Miller, 1992. "Exchange Rate Targets and Currency Bands," NBER Books, National Bureau of Economic Research, Inc, number krug92-1, July.
    11. Kenneth A. Froot & Maurice Obstfeld, 1989. "Stochastic Process Switching: Some Simple Solutions," NBER Working Papers 2998, National Bureau of Economic Research, Inc.
    12. Froot, Kenneth & Obstfeld, Maurice, 1991. "Exchange Rate Dynamics Under Stochastic Regime Shifts: A Unified Approach," CEPR Discussion Papers, C.E.P.R. Discussion Papers 522, C.E.P.R. Discussion Papers.
    13. Smith, Gregor W, 1991. "Solution to a Problem of Stochastic Process Switching," Econometrica, Econometric Society, Econometric Society, vol. 59(1), pages 237-39, January.
    14. Lewis, Karen K, 1995. "Occasional Interventions to Target Rates," American Economic Review, American Economic Association, American Economic Association, vol. 85(4), pages 691-715, September.
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    Cited by:
    1. Brandner, Peter & Grech, Harald & Stix, Helmut, 2006. "The effectiveness of central bank intervention in the EMS: The post 1993 experience," Journal of International Money and Finance, Elsevier, Elsevier, vol. 25(4), pages 580-597, June.
    2. repec:onb:oenbwp:y::i:55:b:1 is not listed on IDEAS

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