Testing the Bounds: Empirical Behavior of Target Zone Fundamentals

J. Miller

No 803, Working Papers from Department of Economics, University of Missouri

Abstract: Standard target zone exchange rate models are based on nonlinear functions of an unobserved economic fundamental, which is assumed to be bounded, similarly to the target zone exchange rates themselves. A violation of this key assumption is a basic structural reason for model failure. Using a novel estimation and testing strategy, we show it is also a testable assumption. Our empirical results cast serious doubt on its validity in practice, providing a primitive reason for well-documented rejections of the basic model. Model failure from this violation is robust to otherwise ideal circumstances (e.g., perfect credibility).

Keywords: target zone exchange rates; economic fundamental; unscented Kalman filter; rescaled range statistic (search for similar items in EconPapers)
JEL-codes: C5 F3 (search for similar items in EconPapers)
Pages: 18 pgs.
Date: 2008-04-07, Revised 2009-04-15
New Economics Papers: this item is included in nep-cba and nep-ifn
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Published in Economic Modelling 2011

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Journal Article: Testing the bounds: Empirical behavior of target zone fundamentals (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:umc:wpaper:0803

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