Assessing Target Zone Credibility: Mean Reversion and Devaluation Expectations in the EMS

35 Pages Posted: 15 Feb 2006  

Lars E. O. Svensson

Stockholm School of Economics; Stockholm University - Institute for International Economic Studies (IIES); National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Date Written: October 1991

Abstract

The paper presents estimates of devaluation expectations for six EMS currencies relative to the Deutsche mark, for the period March 1979-May 1990. The estimation method is simple and operational, and consistently generates sensible results. The estimates are constructed by the adjusting interest rate differentials by subtracting estimated expected rates of depreciation within the exchange rate band. The adjustment is nontrivial because exchange rates within the ERM bands display mean reversion rather than random walk (unit root) behavior. The adjustment is essential since the expected rates of depreciation are usually of about the same magnitude as the interest rate differentials.

JEL Classification: F31, F33

Suggested Citation

Svensson, Lars E. O., Assessing Target Zone Credibility: Mean Reversion and Devaluation Expectations in the EMS (October 1991). IMF Working Paper No. 91/96. Available at SSRN: https://ssrn.com/abstract=885077

Lars E.O. Svensson (Contact Author)

Stockholm School of Economics ( email )

PO Box 6501
Stockholm, 11383
Sweden

HOME PAGE: http://larseosvensson.se

Stockholm University - Institute for International Economic Studies (IIES) ( email )

Stockholm, SE-10691
Sweden

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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