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Assessing Target Zone Credibility: Mean Reversion and Devaluation Expectations in the EMS
Author:
Mr. Lars E. O. Svenssonnull

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Series:
IMF Working Papers
Volume/Issue:
Volume 1991: Issue 096
Language:
English
Publication Date:
01 Oct 1991
DOI:
https://doi.org/10.5089/9781451949964.001
ISBN:
9781451949964
ISSN:
1018-5941
Pages:
35
Keywords:
WP; mean reversion; interest rate differential; DM exchange rate; devaluation expectation; expected rates of depreciation; rate of devaluation; Exchange rates; Depreciation; Crawling peg; Currencies; Exchange rate risk
Legal-disclaimer:
IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
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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.
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Cover IMF Working Papers
IMF Working Papers
ISSN:
1018-5941
Publisher:
International Monetary Fund
Volume 1991: Issue 096