Assessing Target Zone Credibility: Mean Reversion and Devaluation Expectations in the EMS

Author/Editor:

Lars E. O. Svensson

Publication Date:

October 1, 1991

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

The 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.

Series:

Working Paper No. 1991/096

Subject:

Crawling peg Currencies Depreciation Exchange rate risk Exchange rates Financial regulation and supervision Foreign exchange Money National accounts Public expenditure review

English

Publication Date:

October 1, 1991

ISBN/ISSN:

9781451949964/1018-5941

Stock No:

WPIEA0961991

Pages:

35

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