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Stochastic Devaluation Risk and the Empirical Fit of Target-Zone Models

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  • Giuseppe Bertola
  • Lars E. O. Svensson

Abstract

A time-varying stochastic devaluation risk is introduced in a model of exchange rate target zones. The model produces realistic patterns of covariation between exchange rates and interest rate differentials, which previous target zone models have been unable to do. A "drift adjustment" method to estimate devaluation expectations from data is suggested.

Suggested Citation

  • 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.
  • Handle: RePEc:oup:restud:v:60:y:1993:i:3:p:689-712.
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