Stochastic Process Switching: Some Simple Solutions

17 Pages Posted: 13 Nov 2007 Last revised: 12 Sep 2010

See all articles by Kenneth Froot

Kenneth Froot

National Bureau of Economic Research (NBER); Harvard University - Business School (HBS)

Maurice Obstfeld

University of California, Berkeley; Peterson Institute for International Economics; National Bureau of Economic Research; Centre for Economic Policy Research

Date Written: June 1989

Abstract

When changes in the economic policy regime occur stochastically, asset prices will reflect the possibility of such shifts. In this paper we apply techniques of regulated Brownian motion to obtain closed-form analytic price solutions when policy reaction functions are subject to prospective changes. We focus on the case in which the authorities promise to peg a currency's exchange rate once it reaches a predetermined future level. We also show how an open-ended commitment to exchange-rate targeting may lead to multiple equilibria.

Suggested Citation

Froot, Kenneth and Obstfeld, Maurice, Stochastic Process Switching: Some Simple Solutions (June 1989). NBER Working Paper No. w2998. Available at SSRN: https://ssrn.com/abstract=463449

Kenneth Froot (Contact Author)

National Bureau of Economic Research (NBER) ( email )

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Harvard University - Business School (HBS) ( email )

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Maurice Obstfeld

University of California, Berkeley ( email )

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Berkeley, CA 94720
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HOME PAGE: http://www.mauriceobstfeld.com

Peterson Institute for International Economics ( email )

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National Bureau of Economic Research ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research ( email )

London
United Kingdom

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