Stochastic Devaluation Risk and the Empirical Fit of Target Zone Models
In our model, an exchange rate fluctuates between given boundaries for random lengths of time and jumps discretely when devaluations occur. We provide explicit solutions for the stochastic processes followed by the exchange rate and by the expected rate of depreciation when the likelihood and the size of devaluations vary stochastically over time. The model produces realistic patterns of covariation between exchange rates and interest rate differentials, and provides interesting interpretations of available empirical evidence. We also specify a technique for inferrring the risk of devaluation from target-zone data.
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- Delgado, F. & Dumas, B., 1990. "Monetary Contracting Between Central Banks And The Design Of Sustainable Exchange-Rate Zones," Weiss Center Working Papers 20-90, Wharton School - Weiss Center for International Financial Research.
- Francisco Delgado & Bernard Dumas, 1990. "Monetary Contracting Between Central Banks and the Design of SustainableExchange-Rate Zones," NBER Working Papers 3440, National Bureau of Economic Research, Inc.
- Bertola, Giuseppe & Caballero, Ricardo, 1991. "Sustainable Intervention Policies and Exchange Rate Dynamics," CEPR Discussion Papers 504, C.E.P.R. Discussion Papers.
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