An Empirical Reassessment of Target-zone Nonlinearities

Anthony Garratt (), Zacharias Psaradakis and Martin Sola

Cambridge Working Papers in Economics from Faculty of Economics, University of Cambridge

Abstract: This paper investigates the presence of target-zone nonlinearities in the Pound Sterling/Deutsche Mark exchange rate for the period of the UK European Exchange Rate Mechanism (ERM) membership, using data with frequency of every two days. Tests against general nonlinear specifications as well as specifications consistent with a stochastic devaluation risk model of exchange rate target zones are carried out using recursive techniques. In addition, the significance of nonlinear effects is analysed within a recursive Bayesian frame-work. The authors find evidence of target-zone nonlinearities in the whole sample, but the recursive analysis yields support for the presence of such nonlinearities only in specific subsamples. The results imply that the reductions in the UK inflation was most likely a consequence of contractionary policies rather than of the expectational effects of the target zone.

Keywords: Bayesian analysis; Bootstrap; Nonlinearity; Recursive tests; Target zones (search for similar items in EconPapers)
JEL-codes: C22 F31 (search for similar items in EconPapers)
Date: 1998-11
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Citations: View citations in EconPapers (2)

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Journal Article: An empirical reassessment of target-zone nonlinearities (2001)
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Persistent link: https://EconPapers.repec.org/RePEc:cam:camdae:9825

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