Expected Devaluation and Economic Fundamentals
Recent incidents of exchange rate collapse have provoked interest in how much these events are determined by economic fundamentals. This paper considers whether interest rate differentials are appropriate measures of the risk of devaluation and whether this measure of devaluation risk reflects the movements of variables that capture internal and external balance. The paper finds that interest rate differentials reflect devaluation risk but that movements in fundamental variables in France and Italy have only a weak effect on devaluation risk. The most significant influence on devaluation risk is the position of the currency in its band in that the lower the exchange value of a currency is within the band, the greater is the perceived risk of devaluation.
Volume (Year): 41 (1994)
Issue (Month): 2 (June)
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