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Trigger Strategies and Price Dynamics in Equity and Foreign Exchange Markets

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  • Paul R. Krugman

Abstract

Trigger strategist-s may be defined as act-ors in asset markets who buy or sell when the price reaches a predetermined level ; t-hey include participants in portfolio insurance schemes in equity markets and central banks who intervene to defend an exchange rate target zone. This paper presents an approach to modeling the effects of trigger strategists, with emphasis on how target zones affect market expectations. It is shown that a commitment to defend a target zone will generate stabilizing expectations within the band, which may generate a "target zone honeymoon" . an extended period in which the announcement of a target. zone stabilizes exchange rates without any need for action on the part of authorities. However, an imperfectly credible target zone is vulnerable to crises in which the market tests the authorities' resolve.

Suggested Citation

  • Paul R. Krugman, 1987. "Trigger Strategies and Price Dynamics in Equity and Foreign Exchange Markets," NBER Working Papers 2459, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:2459
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    References listed on IDEAS

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    1. Flood, Robert P & Garber, Peter M, 1983. "A Model of Stochastic Process Switching," Econometrica, Econometric Society, vol. 51(3), pages 537-551, May.
    2. Connolly, Michael B & Taylor, Dean, 1984. "The Exact Timing of the Collapse of an Exchange Rate Regime and Its Impact on the Relative Price of Traded Goods," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 16(2), pages 194-207, May.
    3. Mussa, Michael, 1979. "Empirical regularities in the behavior of exchange rates and theories of the foreign exchange market," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 11(1), pages 9-57, January.
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