The Distribution of Exchange Rates in the EMS

Charles Engel and Craig Hakkio

No 4834, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Exchange rates of currencies in the Exchange Rate Mechanism of the EMS are characterized by long periods of stability interrupted by periods of extreme volatility. The periods of volatility appear at times of realignments of the central parities and at times when the exchange rate is within the ERM bands. We begin by considering a procedure for finding outliers based on measuring distance as a quadratic form. The evidence suggests that the exchange rates of the EMS can be described by a mixture of two distributions. We therefore model the exchange rate as switching between two distributions--one that holds in stable times and the other that holds in volatile times. In particular, we use Hamilton's Markov-switching model. In addition, we extend Hamilton's model by allowing the probability of switching from one state to another to depend on the position of the exchange rate within its EMS band. This model has the interesting implication that near the edge of the band, large movements--either realignments or large jumps to the center of the band--are more likely if the move to the edge of the band has been precipitous.

JEL-codes: F3 F4 (search for similar items in EconPapers)
Date: 1994-08
Note: IFM
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (48)

Published as International Journal of Finance and Economics, Vol. 1, pp. 55-67. 1996.

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Related works:
Journal Article: The Distribution of Exchange Rates in the EMS (1996)
Working Paper: The distribution of exchange rates in the EMS (1994)
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