Target zone dynamics where the fundamental follows a SDE with periodic forcing
This paper investigates exchange rate and reserves dynamics in a target zone where the fundamental follows a stochastic differential equation with a periodic forcing function. Solutions to the model show that the target zone plays a stabilizing role but the dynamics of the exchange rate follow a family of S-shaped functions as time evolves. This dynamics cause the width of the target zone to be a varying function of time. It becomes what we can call a flexible target zone. The monetary authorities are then forced to hold not only large reserves but also varying reserves in order to properly defend the target zone.
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Volume (Year): 363 (2006)
Issue (Month): 2 ()
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