Conditional Distributions in the Krugman Target Zone Model and Undeclared Narrower Bands

Dirk Veestraeten ()
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Dirk Veestraeten: Vrije Universiteit Amsterdam and K.U.Leuven, C.E.S., International Economics

International Economics Working Papers Series from Katholieke Universiteit Leuven, Centrum voor Economische Studiën, International Economics

Abstract: The paper explicitly derives the conditional distribution of exchange rates and interest rate differentials in the target zone model of Krugman (1991). The exact conditional density function is subsequently utilized in maximum likelihood estimation in which narrower undeclared bands within officially announced target zone limits are allowed for. Estimation results for the four ERM-currencies under consideration reveal that the presence of target zone nonlinearities can not be rejected. The results for the Dutch guilder and the Italian lira thus are in clear contradiction to the findings reported in Ball and Roma (1994) and de Jong (1994) who, however, relied on approximations of the density function. Moreover, the existence of asymmetrically spaced implicit bands can not be rejected for the Belgian and French francs and the Italian lira.

Keywords: Brownian motion; exchange rates; interest rate differentials; probability densities; reflecting barriers; target zones (search for similar items in EconPapers)
JEL-codes: F31 F33 (search for similar items in EconPapers)
Pages: 23 pages
Date: 2000-12
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