The Simplest Test of Target Zone Credibility
1990 (English)Report (Other academic)
A credible target zone regime with a given exchange rate band implies bounds on the amount of depreciation of the domestic currency. This implies, for given foreign interest rates, bounds on the domestic-currency rate of return on foreign investment: a rate-of-return band for each time to maturity. Whether domestic interest rates are outside theses rate-of-return bands can be used as a simple test of exchange rate credibility, under the assumption of sufficient international capital mobility. This test is applied to the Swedish target zone during February 1986 - February 1990.
Under the additional assumption of uncovered interest rate parity, an equivalent test is whether expected future exchange rates are outside the exchange rate band. In addition, the expected future exchange rates are used to give an estimate of the probability of future devaluations.
Place, publisher, year, edition, pages
Stockholm: IIES , 1990.
Seminar Paper / Institute for International Economic Studies, Stockholm University, ISSN 0347-8769 ; 469
exchange rates, target zones, credibility, devaluation risks, term structure, interest rate bands
IdentifiersURN: urn:nbn:se:su:diva-41773OAI: oai:DiVA.org:su-41773DiVA: diva2:337718