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Conditional Distributions in the Krugman Target Zone Model and Undeclared Narrower Bands

Author

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  • Dirk Veestraeten

    () (Vrije Universiteit Amsterdam and K.U.Leuven, C.E.S., International Economics)

Abstract

The paper explicitly derives the conditional distribution of exchange rates and interest rate differentials in the target zone model of Krugman (1991). The exact conditional density function is subsequently utilized in maximum likelihood estimation in which narrower undeclared bands within officially announced target zone limits are allowed for. Estimation results for the four ERM-currencies under consideration reveal that the presence of target zone nonlinearities can not be rejected. The results for the Dutch guilder and the Italian lira thus are in clear contradiction to the findings reported in Ball and Roma (1994) and de Jong (1994) who, however, relied on approximations of the density function. Moreover, the existence of asymmetrically spaced implicit bands can not be rejected for the Belgian and French francs and the Italian lira.

Suggested Citation

  • Dirk Veestraeten, 2000. "Conditional Distributions in the Krugman Target Zone Model and Undeclared Narrower Bands," International Economics Working Papers Series ces0102, Katholieke Universiteit Leuven, Centrum voor Economische Studiën, International Economics.
  • Handle: RePEc:kul:kulwps:ces0102
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    File URL: http://www.econ.kuleuven.ac.be/ew/admin/Publications/Dps0102.pdf
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    Keywords

    Brownian motion; exchange rates; interest rate differentials; probability densities; reflecting barriers; target zones;

    JEL classification:

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

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