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Empirical Features of the Second-Generation Target Zone Models: Mean-Reverting Fundamentals and Endogenous Devaluation Risk

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  • Knot, Klaas H W
  • Dijkstra, Theo K
  • De Haan, Jakob

Abstract

We show that within Bertola and Svensson's second-generation target zone model, mean-reverting interventions and endogenous devaluation risk are closely interrelated. Over the period 1983-93 we analyze the degree of mean reversion in the underlying fundamental process as well as the term structure of interest rate differentials vis-a-vis Germany for six Exchange Rate Mechanism currencies. For Austria, Denmark and the Netherlands, and for Belgium after 1990 our estimates are broadly in line with the first-generation target zone model, whereas those for France and Italy are in accordance with the model that allows for endogenous devaluation risk. Copyright 1999 by Oxford University Press.

Suggested Citation

  • Knot, Klaas H W & Dijkstra, Theo K & De Haan, Jakob, 1999. "Empirical Features of the Second-Generation Target Zone Models: Mean-Reverting Fundamentals and Endogenous Devaluation Risk," Economic Inquiry, Western Economic Association International, vol. 37(3), pages 489-509, July.
    • Handle: RePEc:oup:ecinqu:v:37:y:1999:i:3:p:489-509
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    Cited by:

    1. Marie Bessec, 2000. "Mean-Reversion versus PPP Adjustment: The Two Regimes of Exchange Rate Dynamics Under the EMS, 1979-1998," Econometric Society World Congress 2000 Contributed Papers 1305, Econometric Society.

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