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Assessing target zone credibility : Mean reversion and devaluation expectations in the ERM, 1979-1992

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  • Svensson, Lars E. O.

Abstract

The paper presents estimates of devaluation expectations for six EMS currencies relative to the Deutsche mark, for the period March 1979-May 1990. The estimation method is simple and operational, and consistently generates sensible results. The estimates are constructed by the adjusting interest rate differentials by subtracting estimated expected rates of depreciation within the exchange rate band. The adjustment is nontrivial because exchange rates within ERM bands display mean reversion rather than random walk (unit root) behavior. The adjustment is essential since expected rates of depreciation within the band are usually of about the same magnitude as interest rate differentials.
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  • Svensson, Lars E. O., 1993. "Assessing target zone credibility : Mean reversion and devaluation expectations in the ERM, 1979-1992," European Economic Review, Elsevier, vol. 37(4), pages 763-793, May.
    • Handle: RePEc:eee:eecrev:v:37:y:1993:i:4:p:763-793
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    Cited by:

    1. Lera, Sandro Claudio & Sornette, Didier, 2016. "Quantitative modelling of the EUR/CHF exchange rate during the target zone regime of September 2011 to January 2015," Journal of International Money and Finance, Elsevier, vol. 63(C), pages 28-47.
    2. Stefan Gerlach & Frank Smets, 1997. "Exchange rate regimes and the expectations hypothesis of the term structure," BIS Working Papers 43, Bank for International Settlements.
    3. Anthony, Myrvin & MacDonald, Ronald, 1999. "The width of the band and exchange rate mean-reversion: some further ERM-based results," Journal of International Money and Finance, Elsevier, vol. 18(3), pages 411-428.
    4. Viktors Ajevskis & Armands Pogulis, 2005. "Repegging of the Lats to the Euro: Implications for the Financial Sector," Working Papers 2005/01, Latvijas Banka.
    5. Viktors Ajevskis & Armands Pogulis & Gunars Berzins, 2004. "Foreign Exchange and Money Markets in the Context of the Exchange Rate Target Zone," Working Papers 2004/01, Latvijas Banka.
    6. WAJIH KHALLOULI & MOHAMED Ayadi & RENE SANDRETTO, 2013. "Fondamentaux, Contagion Et Dynamique Des Anticipations :Une Evaluation A Partir De La Crise Financiere Coreenne," Brussels Economic Review, ULB -- Universite Libre de Bruxelles, vol. 56(2), pages 175-189.
    7. Hui, C.H. & Lo, C.F., 2009. "A note on estimating realignment probabilities - A first-passage-time approach," Journal of International Money and Finance, Elsevier, vol. 28(5), pages 804-812, September.
    8. Darvas, Zsolt, 1999. "Az árfolyamsávok empirikus modelljei és a devizaárfolyam sávon belüli előrejelezhetetlensége
      [Empirical models of exchange rate target zones]      ," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(6), pages 507-529.
    9. Anthony, Myrvin & MacDonald, Ronald, 1998. "On the mean-reverting properties of target zone exchange rates: Some evidence from the ERM," European Economic Review, Elsevier, vol. 42(8), pages 1493-1523, September.
    10. Hallwood, C. Paul & Marsh, Ian W., 2004. "Exchange market pressure on the pound-dollar exchange rate: 1925-1931," The North American Journal of Economics and Finance, Elsevier, vol. 15(2), pages 249-264, August.
    11. Jean-Pierre Laffargue & Sanvi Avouyi-Dovi, 1992. "Anticipations stabilisatrices dans un système de serpent monétaire. Théorie et application au système monétaire européen," Revue Économique, Programme National Persée, vol. 43(6), pages 1107-1128.
    12. Cho-Hoi Hui & Chi-Fai Lo, 2008. "A Note on Estimating Realignment Probabilities -- A First-Passage-Time Approach," Working Papers 0809, Hong Kong Monetary Authority.
    13. Binder, Carola Conces, 2016. "Estimation of historical inflation expectations," Explorations in Economic History, Elsevier, vol. 61(C), pages 1-31.
    14. Lundbergh, Stefan & Terasvirta, Timo, 2006. "A time series model for an exchange rate in a target zone with applications," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 579-609.
    15. Alexandra Janssen & Rahel Studer, 2014. "The Swiss franc's honeymoon," ECON - Working Papers 170, Department of Economics - University of Zurich, revised Jan 2017.
    16. MacDonald, Ronald & Moore, Michael J., 2001. "The spot-forward relationship revisited: an ERM perspective," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 11(1), pages 29-52, March.
    17. Araújo, Aloísio Pessoa de & Feijó Filho, Cypriano Lopes, 1994. "Bandas de cambio : teoria, evidencia empirica e sua possivel aplicação no Brasil," FGV/EPGE Economics Working Papers (Ensaios Economicos da EPGE) 234, FGV/EPGE - Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
    18. Genberg, Hans & Hui, Cho-Hoi, 2008. "The credibility of 'The Link' from the perspective of modern financial theory," IMFS Working Paper Series 18, Goethe University Frankfurt, Institute for Monetary and Financial Stability (IMFS).
    19. Boris Blagov & Michael Funke, 2016. "The Credibility of Hong Kong's Currency Board System: Looking Through the Prism of MS-VAR Models with Time-Varying Transition Probabilities," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 78(6), pages 895-914, December.
    20. Elias D. Belessakos & Christos I. Giannikos, 2002. "The "Lack" of Volatility Trade-Offs in Exchange Rate Zones with Sticky Prices," International Journal of Business and Economics, College of Business and College of Finance, Feng Chia University, Taichung, Taiwan, vol. 1(1), pages 69-78, April.
    21. Peter Carr & Zura Kakushadze, 2015. "FX Options in Target Zone," Papers 1512.01527, arXiv.org, revised Jul 2016.
    22. C. H. Hui & C. F. Lo & V. Yeung & L. Fung, 2008. "Valuing foreign currency options with a mean-reverting process: a study of Hong Kong dollar," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 13(1), pages 118-134.
    23. Gabriela Mundaca, B., 2000. "The effect of interventions on realignment probabilities," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 10(3-4), pages 323-347, December.
    24. Jeanne, Olivier, 1997. "Are currency crises self-fulfilling?: A test," Journal of International Economics, Elsevier, vol. 43(3-4), pages 263-286, November.
    25. Amato, Amedeo & Tronzano, Marco, 2000. "Fiscal policy, debt management and exchange rate credibility: Lessons from the recent Italian experience," Journal of Banking & Finance, Elsevier, vol. 24(6), pages 921-943, June.

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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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