A Model of Stochastic Process Switching
Robert P. Flood
International Monetary Fund (IMF) - Research Department; CENTRUM Business School; National Bureau of Economic Research (NBER)
Peter M. Garber
Brown University - Department of Economics; National Bureau of Economic Research (NBER)
NBER Working Paper No. w0626
In this paper we develop a rational expectations exchange rate model which is capable of confronting explicitly agents' beliefs about a future switch in exogenous driving processes. In our set-up the agents know with certainty both the initial exogenous process and the new process to be adopted when the switch occurs. However, they do not know with certainty the timing of future switch as it depends on the path followed by the (stochastic) exchange rate. The model is discussed in terms of the British return to pre-war parity, in 1925. However, our results are applicable to a variety of situations where process switching depends on the motion of a key endogenous variable.
Number of Pages in PDF File: 19working papers series
Date posted: June 28, 2001
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