Citation

Discussion Paper Details

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Title: Stochastic Devaluation Risk and the Empirical Fit of Target Zone Models

Author(s): Giuseppe Bertola and Lars E.O. Svensson

Publication Date: February 1991

Keyword(s): Devaluations, Exchange Rates, Interest Rate Differentials and Target Zones

Programme Area(s): International Macroeconomics

Abstract: In our model, an exchange rate fluctuates between given boundaries for random lengths of time and jumps discretely when devaluations occur. We provide explicit solutions for the stochastic processes followed by the exchange rate and by the expected rate of depreciation when the likelihood and the size of devaluations vary stochastically over time. The model produces realistic patterns of covariation between exchange rates and interest rate differentials, and provides interesting interpretations of available empirical evidence. We also specify a technique for inferrring the risk of devaluation from target-zone data.

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Bibliographic Reference

Bertola, G and Svensson, L. 1991. 'Stochastic Devaluation Risk and the Empirical Fit of Target Zone Models'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=513