The Simplest Test of Target Zone Credibility

Lars Svensson

No 493, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: Under the assumption of no arbitrage, exchange rate target-zone credibility is tested by whether domestic interest rates fall within `rate-of-return bands' between the maximum and minimum home-currency rate of return on a foreign investment in the absence of a devaluation. Under the assumption of uncovered interest rate parity, credibility is tested by whether expected future exchange rates fall within the exchange rate band. Under the assumption that devaluations are a Poisson process, the expected exchange rate, the probability intensity and the expected size of a devaluation can be related. These tests are illustrated using data on the Swedish target zone between January 1987 and August 1990.

Keywords: Credibility; Devaluation Risk; Exchange Rates; Interest Rate Bands; Target Zones; Term Structure (search for similar items in EconPapers)
Date: 1991-01
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Related works:
Journal Article: The Simplest Test of Target Zone Credibility (1991)
Working Paper: The Simplest Test of Target Zone Credibility (1990)
Working Paper: The Simplest Test of Target Zone Credibility (1990)
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