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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. Flood, Robert P & Garber, Peter M, 1991. "The Linkage between Speculative Attack and Target Zone Models of Exchange Rates," The Quarterly Journal of Economics, MIT Press, vol. 106(4), pages 1367-72, November.
    2. Bertola, Giuseppe & Caballero, Ricardo, 1990. "Target Zones and Realignments," CEPR Discussion Papers 398, C.E.P.R. Discussion Papers.
    3. 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.
    4. Kenneth A. Froot & Maurice Obstfeld, 1992. "Exchange Rate Dynamics Under Stochastic Regime Shifts: A Unified Approach," NBER Working Papers 2835, National Bureau of Economic Research, Inc.
    5. Lars E.O. Svensson, 1989. "Target Zones and Interest Rate Variability," NBER Working Papers 3218, National Bureau of Economic Research, Inc.
    6. Krugman, Paul R, 1991. "Target Zones and Exchange Rate Dynamics," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 669-82, August.
    7. 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.
    8. Froot, Kenneth A & Obstfeld, Maurice, 1991. "Stochastic Process Switching: Some Simple Solutions," Econometrica, Econometric Society, vol. 59(1), pages 241-50, January.
    9. Robert P. Flood & Peter M. Garber, 1981. "A Model of Stochastic Process Switching," NBER Working Papers 0626, National Bureau of Economic Research, Inc.
    10. Lewis, Karen K, 1995. "Occasional Interventions to Target Rates," American Economic Review, American Economic Association, vol. 85(4), pages 691-715, September.
    11. Smith, Gregor W, 1991. "Solution to a Problem of Stochastic Process Switching," Econometrica, Econometric Society, vol. 59(1), pages 237-39, January.
    12. Paul Krugman & Marcus Miller, 1992. "Exchange Rate Targets and Currency Bands," NBER Books, National Bureau of Economic Research, Inc, number krug92-1, October.
    13. Mussa, Michael, 1982. "A Model of Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 90(1), pages 74-104, February.
    14. Nelson, Daniel B., 1990. "ARCH models as diffusion approximations," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 7-38.
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    Cited by:
    1. Peter Brandner & Harald Grech & Helmut Stix, 2001. "The Effectiveness of Central Bank Intervention in the EMS. The Post 1993 Experience," WIFO Working Papers 168, WIFO.
    2. repec:onb:oenbwp:y::i:55:b:1 is not listed on IDEAS

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