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Title: Exchange Rate Dynamics Under Stochastic Regime Shifts: A Unified Approach

Author(s): Kenneth Froot and Maurice Obstfeld

Publication Date: February 1991

Keyword(s): Regime Change, Regulated Brownian Motion and Target Zone

Programme Area(s): International Macroeconomics

Abstract: Simple techniques of regulated Brownian motion are used to analyse the behaviour of the exchange rate when official policy reaction functions are subject to future stochastic changes. We examine exchange rate dynamics in cases where the authorities promise (i) to confine a floating rate within a predetermined range, (ii) to peg the currency once it reaches a predetermined future level, and (iii) to unify a system of dual exchange rates. Similarities between these and several related examples of regime switching are stressed. We also discuss how stochastic regime changes can affect some standard statistical tests of hypotheses about exchange rates.

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Bibliographic Reference

Froot, K and Obstfeld, M. 1991. 'Exchange Rate Dynamics Under Stochastic Regime Shifts: A Unified Approach'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=522