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Noisy signals in target zone regimes:: Theory and Monte Carlo experiments

  • Holden, Steinar
  • Kolsrud, Dag

Previous empirical evidence indicates that uncovered interest rate parity (UIP) does not hold for target zone exchange rates, like those in the European Monetary System and in the Nordic countries. We explore a target zone model where the market inferes the probability of a realignment of the band on the basis of a noisy signal. We show theoretically and through Monte Carlo simulations that if the market overrates the information content in the signal, then this may explain the empirical results obtained from testing UIP for target zone exchange rates.

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Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 43 (1999)
Issue (Month): 8 (August)
Pages: 1531-1567

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Handle: RePEc:eee:eecrev:v:43:y:1999:i:8:p:1531-1567
Contact details of provider: Web page: http://www.elsevier.com/locate/eer

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