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Estimating credibility in Colombia's exchange-rate target zone

  • Galindo, Arturo J.

This paper analyzes credibility in the Colombian exchange rate target zone. A model of imperfect credibility, in the spirit of Bertola and Svensson (1993) is derived, and is used to explain why the exchange rate in Colombia has remained for prolonged periods neathe borders of the zone. The main feature of the model is that central parity depreciation expectations are endogenous with respect to the position of the exchange rate inside the target zone. The Krugman (1991) perfectly credible setup turns out to be a particular case of this general model. One of the main impliations of the model is that depreciation expectations increase rather than decrease as the exchange rate approaches the upper band. Hence a model as the one presented in this paper, is useful to explain the recent dynamics of interest rates in Colombia. It is also shown, that this model shares empirical feactures with the basic target zone model. Hence, policy makers might be misled when trying to recognize their credibility stance. A structural estimation of the underlying parameters of the model, using McFadden's (1989) method of simulated moments, is suggestedto identify the presence of non credibility issues. Econometric evidence suggest that Colombia's exchange rate target zone is properly described by a model of this nature.

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Article provided by Elsevier in its journal Journal of Development Economics.

Volume (Year): 63 (2000)
Issue (Month): 2 (December)
Pages: 473-484

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Handle: RePEc:eee:deveco:v:63:y:2000:i:2:p:473-484
Contact details of provider: Web page: http://www.elsevier.com/locate/devec

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  1. Lee, Bong-Soo & Ingram, Beth Fisher, 1991. "Simulation estimation of time-series models," Journal of Econometrics, Elsevier, vol. 47(2-3), pages 197-205, February.
  2. de Jong, F, 1994. "A Univariate Analysis of EMS Exchange Rates Using a Target Zone Model," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 9(1), pages 31-45, Jan.-Marc.
  3. Lars E.O. Svensson, 1989. "Target Zones and Interest Rate Variability," NBER Working Papers 3218, National Bureau of Economic Research, Inc.
  4. Cukierman, A. & Kiguel, M.A. & Leiderman, L., 1993. "The Choice of Exchange Rate Bands: Balancing Credibility and Flexibility," Papers 1-93, Tel Aviv - the Sackler Institute of Economic Studies.
  5. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
  6. Peter M. Garber & Lars E.O. Svensson, 1994. "The Operation and Collapse of Fixed Exchange Rate Regimes," NBER Working Papers 4971, National Bureau of Economic Research, Inc.
  7. Bertola, G. & Svensson, L.E., 1990. "Stochastic Devaluation Risk and the Empirical Fit of Target Zone Models," Papers 481, Stockholm - International Economic Studies.
  8. Rose, Andrew K & Svensson, Lars E O, 1991. "Expected and Predicted Realignments: The FF/DM Exchange Rate During the EMS," CEPR Discussion Papers 552, C.E.P.R. Discussion Papers.
  9. Chinn, Menzie D. & Meese, Richard A., 1995. "Banking on currency forecasts: How predictable is change in money?," Journal of International Economics, Elsevier, vol. 38(1-2), pages 161-178, February.
  10. Bekaert, Geert & Gray, Stephen F., 1998. "Target zones and exchange rates:: An empirical investigation," Journal of International Economics, Elsevier, vol. 45(1), pages 1-35, June.
  11. Raúl A. Feliz & John H. Welch, 1994. "Un análisis de la credibilidad y del comportamiento de las bandas unilaterales de los tipos de cambio en México y Chile," Economía Mexicana NUEVA ÉPOCA, , vol. 0(1), pages 5-30, January-J.
  12. Lindberg, H. & Soderlind, P., 1991. "Testing the Basic Target Zone Model on Swedish Data," Papers 488, Stockholm - International Economic Studies.
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  14. Richard Meese & Kenneth Rogoff & Jacob Frenkel, . "The Out-of-Sample Failure of Empirical Exchange Rate Models: Sampling Error or Misspecification?," Working Paper 32044, Harvard University OpenScholar.
  15. 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.
  16. Paul R. Krugman, 1988. "Target Zones and Exchange Rate Dynamics," NBER Working Papers 2481, National Bureau of Economic Research, Inc.
  17. Mizrach, Bruce, 1995. "Target zone models with stochastic realignments: an econometric evaluation," Journal of International Money and Finance, Elsevier, vol. 14(5), pages 641-657, October.
  18. Lindberg, Hans & Soderlind, Paul, 1994. " Intervention Policy and Mean Reversion in Exchange Rate Target Zones: The Swedish Case," Scandinavian Journal of Economics, Wiley Blackwell, vol. 96(4), pages 499-513.
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