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Explaining Devaluation Expectations in the EMS

  • Stenfors, Alexis
  • Söderström, Ulf

This paper is an attempt to explain devaluation expectations in the ERM with macroeconomic fundamentals. Two different measures of devaluation expectations are used; expectations estimated using the drift-adjustment method of Bertola and Svensson [1993] and the directly observable interest rate differential. The interest rate differential seems more closely connected to macroeconomic fundamentals than the estimates stemming from the drift- adjustment metod. For the ERM as a whole, an expanded theoretic model of exchange rate determination explains a considerable part of the devaluation expectations, whereas for individual countries additional variables are important, and the relationships are ambiguous and country specific.

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Paper provided by Stockholm School of Economics in its series SSE/EFI Working Paper Series in Economics and Finance with number 20.

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Length: 30 pages
Date of creation: Jun 1994
Date of revision:
Publication status: Published in Finnish Economic Papers, 1995, pages 63-81
Handle: RePEc:hhs:hastef:0020
Contact details of provider: Postal: The Economic Research Institute, Stockholm School of Economics, P.O. Box 6501, 113 83 Stockholm, Sweden
Phone: +46-(0)8-736 90 00
Fax: +46-(0)8-31 01 57
Web page: http://www.hhs.se/
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  1. Lars E.O. Svensson, 1990. "The Simplest Test of Target Zone Credibility," NBER Working Papers 3394, National Bureau of Economic Research, Inc.
  2. Paul R. Krugman, 1988. "Target Zones and Exchange Rate Dynamics," NBER Working Papers 2481, National Bureau of Economic Research, Inc.
  3. Zhaohui Chen & Alberto Giovannini, 1992. "Estimating Expected Exchange Rates Under Target Zones," NBER Working Papers 3955, National Bureau of Economic Research, Inc.
  4. Vincent Koen, 1991. "Testing the Credibility of the Belgian Hard Currency Policy," IMF Working Papers 91/79, International Monetary Fund.
  5. Hansen, Lars Peter & Hodrick, Robert J, 1980. "Forward Exchange Rates as Optimal Predictors of Future Spot Rates: An Econometric Analysis," Journal of Political Economy, University of Chicago Press, vol. 88(5), pages 829-53, October.
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