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The Simplest Test of Target Zone Credibility

  • Lars E. O. Svensson

    (International Monetary Fund)

Under the assumption of no arbitrage, the credibility of an exchange rate target zone is tested by whether domestic interest rates fall within "rate-of-return bands" between the maximum and minimum home currency rate of return on a foreign investment in the absence of a devaluation. Under the assumption of uncovered interest parity, credibility is tested by whether expected future exchange rates fall within the exchange rate band. These tests are applied on data on the Swedish target zone from January 1987 through August 1990.

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Article provided by Palgrave Macmillan in its journal Staff Papers - International Monetary Fund.

Volume (Year): 38 (1991)
Issue (Month): 3 (September)
Pages: 655-665

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Handle: RePEc:pal:imfstp:v:38:y:1991:i:3:p:655-665
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  1. Paul R. Krugman, 1988. "Target Zones and Exchange Rate Dynamics," NBER Working Papers 2481, National Bureau of Economic Research, Inc.
  2. Svensson, Lars E O, 1991. "The Term Structure of Interest Rate Differentials in a Target Zone: Theory and Swedish Data," CEPR Discussion Papers 495, C.E.P.R. Discussion Papers.
  3. Lars E.O. Svensson, 1990. "The Foreign Exchange Risk Premium in a Target Zone with Devaluation Risk," NBER Working Papers 3466, National Bureau of Economic Research, Inc.
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