EconPapers    
Economics at your fingertips  
 

Can Exchange Rate Dynamics in Krugman¡¯s Target-zone Model be Directly Tested?Abstract: Despite Krugman's (1991) model being a benchmark for modelling target zones, empirical support has been sparse due to the subtle non-linear relationship between the observable exchange rate and underlying unobservable fundamental. This paper provides an alternative approach to derive explicit exchange rate dynamics by approximating a quadratic relationship between the exchange rate and fundamental through a power-series method. The exchange rate dynamics with a parametric class of drift terms of the stochastic fundamental, including zero-trend (Krugman¡¯s model), symmetric and asymmetric mean-reverting forces regarding how central banks intervene are ready for direct empirical tests. The empirical results demonstrate that the derived dynamics following a square-root process (in Krugman¡¯s model), or mean-reverting square-root process, adequately fit the exchange rate data of various target-zone systems including the Exchange Rate Mechanism and the Linked Exchange Rate System of the Hong Kong dollar. The model parameters of the exchange rate dynamics under the asymmetric mean-reverting fundamental are shown to be associated with realignment of the currencies¡¯ target zones

Cho-Hoi Hui, Chi-Fai Lo and Po-Hon Chau
Additional contact information
Cho-Hoi Hui: Hong Kong Monetary Authority
Chi-Fai Lo: The Chinese University of Hong Kong
Po-Hon Chau: The Chinese University of Hong Kong

Working Papers from Hong Kong Institute for Monetary Research

JEL-codes: F31 (search for similar items in EconPapers)
Date: 2017-02
References: View references in EconPapers View complete reference list from CitEc
Citations: Track citations by RSS feed

Downloads: (external link)
http://www.hkimr.org/uploads/publication/457/wp201703.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:hkm:wpaper:032017

Access Statistics for this paper

More papers in Working Papers from Hong Kong Institute for Monetary Research Contact information at EDIRC.
Bibliographic data for series maintained by HKIMR ().

 
Page updated 2019-07-12
Handle: RePEc:hkm:wpaper:032017