Optimal Currency Target Zones: How Wide Should Exchange Rate Bands Be?
This paper presents a model of an optimal currency band in which a central bank with an infinite time horizon faces a trade-off between interest rate deviation costs and exchange rate deviation costs. The bank chooses optimal intervention points in order to minimize the value of the loss function. The paper uses the Bellman inequalities for instantaneous control of the regulated Brownian motion to derive an optimal currency band and optimal intervention policy characterized by two barriers. This model derives some interesting results. First, the width of currency band depends positively on the uncertainty of the shock, the degree of speculative pressure, and central bank's concern about the domestic money market versus the foreign exchange market. Second, the central bank finds it optimal not to intervene when the fundamental rate is inside a certain band, whereas once it lies outside the band, the optimal policy is to move it to the nearest boundary. [F31]
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Volume (Year): 15 (2001)
Issue (Month): 1 ()
|Contact details of provider:|| Web page: http://www.tandfonline.com/RIEJ20|
|Order Information:||Web: http://www.tandfonline.com/pricing/journal/RIEJ20|
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Robert P. Flood & Peter M. Garber, 1991. "The Linkage Between Speculative Attack and Target Zone Models of Exchange Rates," The Quarterly Journal of Economics, Oxford University Press, vol. 106(4), pages 1367-1372.
- J. Michael Harrison & Michael I. Taksar, 1983. "Instantaneous Control of Brownian Motion," Mathematics of Operations Research, INFORMS, vol. 8(3), pages 439-453, August.
- Svensson, Lars E. O., 1991.
"Target zones and interest rate variability,"
Journal of International Economics,
Elsevier, vol. 31(1-2), pages 27-54, August.
- Svensson, L.E.O., 1989. "Target Zones And Interest Rate Variability," Papers 457, Stockholm - International Economic Studies.
- Svensson, Lars E O, 1990. "Target Zones and Interest Rate Variability," CEPR Discussion Papers 372, C.E.P.R. Discussion Papers.
- Lars E. O. Svensson, 1990. "Target Zones and Interest Rate Variability," IMF Working Papers 90/31, International Monetary Fund.
- Lars E.O. Svensson, 1989. "Target Zones and Interest Rate Variability," NBER Working Papers 3218, National Bureau of Economic Research, Inc.
- Stephen W. Salant & Dale W. Henderson, 1976. "Market anticipations, government policy, and the price of gold," International Finance Discussion Papers 81, Board of Governors of the Federal Reserve System (U.S.).
- Miller, Marcus & Zhang, Lei, 1996. "Optimal target zones: How an exchange rate mechanism can improve upon discretion," Journal of Economic Dynamics and Control, Elsevier, vol. 20(9-10), pages 1641-1660.
- Miller, Marcus & Zhang, Lei, 1994. "Optimal Target Zones: How an Exchange Rate Mechanism Can Improve Upon Discretion," CEPR Discussion Papers 1031, C.E.P.R. Discussion Papers.
- Labhard, Vincent & Wyplosz, Charles, 1996. "The New EMS: Narrow Bands inside Deep Bands," American Economic Review, American Economic Association, vol. 86(2), pages 143-146, May.
- Salant, Stephen W, 1983. "The Vulnerability of Price Stabilization Schemes to Speculative Attack," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 1-38, February.
- Salant, Stephen W & Henderson, Dale W, 1978. "Market Anticipations of Government Policies and the Price of Gold," Journal of Political Economy, University of Chicago Press, vol. 86(4), pages 627-648, August.
- Froot, Kenneth A. & Obstfeld, Maurice, 1991. "Exchange-rate dynamics under stochastic regime shifts : A unified approach," Journal of International Economics, Elsevier, vol. 31(3-4), pages 203-229, November.
- Kenneth A. Froot & Maurice Obstfeld, 1989. "Exchange Rate Dynamics Under Stochastic Regime Shifts: A Unified Approach," NBER Working Papers 2835, National Bureau of Economic Research, Inc.
- Froot, Kenneth & Obstfeld, Maurice, 1991. "Exchange Rate Dynamics Under Stochastic Regime Shifts: A Unified Approach," CEPR Discussion Papers 522, C.E.P.R. Discussion Papers.
- Maurice Obstfeld, 1988. "The Effectiveness of Foreign-Exchange Intervention: Recent Experience," NBER Working Papers 2796, National Bureau of Economic Research, Inc. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:taf:intecj:v:15:y:2001:i:1:p:61-93. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Michael McNulty)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.