Exchange Rate Mean Reversion within a Target Zone: Evidence from a Country on the Periphery of the ERM

António Portugal Duarte (), João Sousa Andrade () and Adelaide Duarte ()
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Adelaide Duarte: Faculdade de Economia/GEMF, Universidade de Coimbra

No 2009-15, GEMF Working Papers from GEMF - Faculdade de Economia, Universidade de Coimbra

Abstract: The aim of this study is to assess to what extent the Portuguese participation in the European Monetary System (EMS) has been characterized by mean reverting behaviour, as predicted by the exchange rate target zone model developed by Krugman (1991). For this purpose, a new class of mean reversion tests is introduced. The empirical analysis of mean reversion in the Portuguese exchange rate shows that most of the traditional unit root and stationarity tests point to the nonstationarity of the exchange rate within the band. However, using a set of variance-ratio tests, it was possible to detect the presence of a martingale difference sequence. This suggests that the Portuguese foreign exchange market has functioned efficiently, allowing us to conclude that the adoption of an exchange rate target zone regime has contributed decisively to the creation of the macroeconomic stability conditions necessary for the participation of Portugal in the euro area.

Keywords: difference sequence; mean reversion; stationarity; target zones and unit roots (search for similar items in EconPapers)
JEL-codes: C32 C51 F31 F41 G15 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-ifn and nep-mon
Date: 2009-11
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Persistent link: http://EconPapers.repec.org/RePEc:gmf:wpaper:2009-15

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