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The Simplest Test of Target Zone Credibility

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  • Lars E. O. Svensson

    (International Monetary Fund)

Abstract

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.

Suggested Citation

  • Lars E. O. Svensson, 1991. "The Simplest Test of Target Zone Credibility," IMF Staff Papers, Palgrave Macmillan, vol. 38(3), pages 655-665, September.
    • Handle: RePEc:pal:imfstp:v:38:y:1991:i:3:p:655-665
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    References listed on IDEAS

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    1. 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.
    2. 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.
    3. Paul R. Krugman, 1988. "Target Zones and Exchange Rate Dynamics," NBER Working Papers 2481, National Bureau of Economic Research, Inc.
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    More about this item

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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