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Explaining devaluation expectations in the EMS

Author

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  • Ulf Söderström

    (Stockholm School of Economics, Sweden)

  • Alexis Stenfors

    (Midland Bank plc, Stockholm Branch, Treasury and Capital Markets, Sweden)

Abstract

This paper is an attempt to explain devaluation expectations in the ERM with macroeconomic fundamentals. Two different measures of devaluation expectations are used; expectations estimated using the drift-adjustment method of Bertola and Svensson (1993), and the directly observable interest rate differential. The interest rate differential seems more closely connected to macroeconomic fundamentals than the estimates stemming from the drift-adjustment method. For the ERM as a whole, an expanded monetary model of exchange rate determination explains a considerable part ofthe devaluation expectations, whereas for individual countries additional variables are important, but the relationships are ambiguous and country-specific.

Suggested Citation

  • Ulf Söderström & Alexis Stenfors, 1995. "Explaining devaluation expectations in the EMS," Finnish Economic Papers, Finnish Economic Association, vol. 8(2), pages 63-81, Autumn.
    • Handle: RePEc:fep:journl:v:8:y:1995:i:2:p:63-81
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    References listed on IDEAS

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    1. Hansen, Lars Peter & Hodrick, Robert J, 1980. "Forward Exchange Rates as Optimal Predictors of Future Spot Rates: An Econometric Analysis," Journal of Political Economy, University of Chicago Press, vol. 88(5), pages 829-853, October.
    2. Lars E. O. Svensson, 1991. "The Simplest Test of Target Zone Credibility," IMF Staff Papers, Palgrave Macmillan, vol. 38(3), pages 655-665, September.
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    5. Mr. Francesco Caramazza, 1993. "French-German Interest Rate Differentials and Time-Varying Realignment Risk," IMF Working Papers 1993/001, International Monetary Fund.
    6. Svensson, Lars E. O., 1992. "The foreign exchange risk premium in a target zone with devaluation risk," Journal of International Economics, Elsevier, vol. 33(1-2), pages 21-40, August.
    7. Zhaohui Chen & Alberto Giovannini, 1993. "The Determinants of Realignment Expectations Under the EMS: Some Empirical Regularities," NBER Working Papers 4291, National Bureau of Economic Research, Inc.
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    12. Garber, Peter M. & Svensson, Lars E.O., 1995. "The operation and collapse of fixed exchange rate regimes," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 36, pages 1865-1911, Elsevier.
    13. Pierre Siklos & Rod Tarajos, 1996. "Fundamentals and devaluation expectations in target zones: Some new evidence from the ERM," Open Economies Review, Springer, vol. 7(1), pages 35-59, January.
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    Cited by:

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    2. Larry Neal & Marc Weidenmier, 2002. "Crises in the Global Economy from Tulips to Today: Contagion and Consequences," NBER Working Papers 9147, National Bureau of Economic Research, Inc.

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    More about this item

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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