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The European Monetary System: Credible at Last?

Listed author(s):
  • Frankel, Jeffrey
  • Phillips, Steven

We update tests of the credibility of the EMS exchange rate target zones. Our main methodological innovation is to use a survey of exchange rate forecasts, as well as interest differentials, in measuring exchange rate expectations. We investigate the hypothesis--suggested by the apparent stabilization of the EMS and by recent institutional developments--that the EMS target zones have experienced an increase in credibility since their 1987 realignment. The evidence tends to support this hypothesis for most currencies studied. We also examine the empirical failure of standard target zone models, but find no evidence that it can be attributed to mismeasurement of expectations. Finally, we consider an alternative credibility measure which captures the importance of possible realignments in overall expectations of exchange rate changes. Copyright 1992 by Royal Economic Society.

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Article provided by Oxford University Press in its journal Oxford Economic Papers.

Volume (Year): 44 (1992)
Issue (Month): 4 (October)
Pages: 791-816

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Handle: RePEc:oup:oxecpp:v:44:y:1992:i:4:p:791-816
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  1. Lars E. O. Svensson, 1991. "The Simplest Test of Target Zone Credibility," IMF Staff Papers, Palgrave Macmillan, vol. 38(3), pages 655-665, September.
  2. Kenneth A. Froot & Jeffrey A. Frankel, 1989. "Forward Discount Bias: Is it an Exchange Risk Premium?," The Quarterly Journal of Economics, Oxford University Press, vol. 104(1), pages 139-161.
  3. Giovannini, Alberto, 1988. "The Time Variation of Risk and Return in the Foreign Exchange and Stock Markets," CEPR Discussion Papers 228, C.E.P.R. Discussion Papers.
  4. Svensson, Lars E. O., 1991. "The term structure of interest rate differentials in a target zone : Theory and Swedish data," Journal of Monetary Economics, Elsevier, vol. 28(1), pages 87-116, August.
  5. Giuseppe Bertola & Lars E. O. Svensson, 1993. "Stochastic Devaluation Risk and the Empirical Fit of Target-Zone Models," Review of Economic Studies, Oxford University Press, vol. 60(3), pages 689-712.
  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. Giovannini, Alberto & Jorion, Philippe, 1989. " The Time Variation of Risk and Return in the Foreign Exchange and Stock Markets," Journal of Finance, American Finance Association, vol. 44(2), pages 307-325, June.
  8. Frankel, Jeffrey A., 1982. "In search of the exchange risk premium: A six-currency test assuming mean-variance optimization," Journal of International Money and Finance, Elsevier, vol. 1(1), pages 255-274, January.
  9. Paul R. Krugman, 1991. "Target Zones and Exchange Rate Dynamics," The Quarterly Journal of Economics, Oxford University Press, vol. 106(3), pages 669-682.
  10. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November.
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