Assessing Target Zone Credibility: Mean Reversion and Devaluation Expectations in the EMSThe paper presents estimates of devaluation expectations for six EMS currencies relative to the Deutsche mark, for the period March 1979-May 1990. The estimation method is simple and operational, and consistently generates sensible results. The estimates are constructed by the adjusting interest rate differentials by subtracting estimated expected rates of depreciation within the exchange rate band. The adjustment is nontrivial because exchange rates within the ERM bands display mean reversion rather than random walk (unit root) behavior. The adjustment is essential since the expected rates of depreciation are usually of about the same magnitude as the interest rate differentials. |
Other editions - View all
Common terms and phrases
88 Figure adjust the interest adjusting interest rate Bertola and Svensson BF/DM central parity Centre for Economic CEPR Discussion Papers Danish krone depreciation within band Deutsche mark devaluation expectations Devaluation Risk Dickey-Fuller test DK/DM Economic Policy Research estimate the expected estimated expected rates estimates of devaluation estimates of expected European Monetary System exchange rate band exchange rate movements exchange risk premium expected conditional devaluation expected conditional realignment expected future exchange FF/DM foreign exchange risk frequency of realignment future exchange rate IL/DM exchange rate intercept interest rate differential IP/DM jump LEO Svensson Lindberg log exchange rate model of expected NG/DM participating currency random walk rate of depreciation rate of devaluation rate of realignment rate within band Regressand Rose and Svensson short regimes slopes small-sample problem Söderlind 1991 standard errors sufficiently long maturities Svensson and Söderlind Swedish krona Table TARGET ZONE CREDIBILITY uncovered interest parity unit root א א א