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Exchange rate dynamics under state-contingent stochastic process switching

  • Naszodi, Anna

This paper offers a closed-form solution of a process switching problem, i.e., switching the exchange rate regime from free-floating to a completely fixed one. An example of such regime change is the adoption of the Euro. In contrast to previous studies on the subject, this paper analyzes a specific case when foreign exchange market participants consider both the Euro locking rate and locking date as uncertain. Preceding the locking, the exchange rate is determined by three factors: fundamental, market expectations for the Euro locking rate, and date. The model is used to examine the conditions under which the exchange rate volatility is mitigated by the prospect of locking.

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File URL: http://www.sciencedirect.com/science/article/pii/S0261560611000659
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Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 30 (2011)
Issue (Month): 5 (September)
Pages: 896-908

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Handle: RePEc:eee:jimfin:v:30:y:2011:i:5:p:896-908
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30443

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  1. Balázs �gert & László Halpern & Ronald MacDonald, 2006. "Equilibrium Exchange Rates in Transition Economies: Taking Stock of the Issues ," Journal of Economic Surveys, Wiley Blackwell, vol. 20(2), pages 257-324, 04.
  2. Wilfling, Bernd & Maennig, Wolfgang, 2001. "Exchange rate dynamics in anticipation of time-contingent regime switching: modelling the effects of a possible delay," Journal of International Money and Finance, Elsevier, vol. 20(1), pages 91-113, February.
  3. Robert P. Flood & Peter M. Garber, 1982. "A model of stochastic process switching," International Finance Discussion Papers 201, Board of Governors of the Federal Reserve System (U.S.).
  4. Maurice Obstfeld & Alan C. Stockman, 1983. "Exchange-Rate Dynamics," NBER Working Papers 1230, National Bureau of Economic Research, Inc.
  5. Kenneth A. Froot & Maurice Obstfeld, 1989. "Exchange Rate Dynamics Under Stochastic Regime Shifts: A Unified Approach," NBER Working Papers 2835, National Bureau of Economic Research, Inc.
  6. Charles Engel & Kenneth D. West, 2003. "Exchange rates and fundamentals," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  7. Sutherland, Alan, 1995. "State- and time-contingent switches of exchange rate regime," Journal of International Economics, Elsevier, vol. 38(3-4), pages 361-374, May.
  8. Froot, Kenneth A & Obstfeld, Maurice, 1991. "Stochastic Process Switching: Some Simple Solutions," Econometrica, Econometric Society, vol. 59(1), pages 241-50, January.
  9. John Williamson, 1994. "Estimating Equilibrium Exchange Rates," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 17.
  10. Djajic, Slobodan, 1989. "Dynamics of the exchange rate in anticipation of pegging," Journal of International Money and Finance, Elsevier, vol. 8(4), pages 559-571, December.
  11. Paul R. Krugman, 1988. "Target Zones and Exchange Rate Dynamics," NBER Working Papers 2481, National Bureau of Economic Research, Inc.
  12. De Grauwe, Paul & Dewachter, Hans & Veestraeten, Dirk, 1999. "Price dynamics under stochastic process switching: some extensions and an application to EMU1," Journal of International Money and Finance, Elsevier, vol. 18(2), pages 195-224, February.
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