Testing a target zones model for the peseta/deutsche mark exchange rate

  1. Campos López, María Isabel
  2. Herrera Revuelta, Julio
  3. Jiménez Ridruejo, Zenón
Journal:
Documentos de trabajo FAE ( Universidad de Valladolid. Facultad de Ciencias Económicas y Empresariales )

Year of publication: 1999

Issue: 6

Pages: 1-32

Type: Working paper

Abstract

The literature on "Target Zones" is characterized by a continuous stochastic time modelization, where the exchange rate is a non-censured dependent variable. In this paper we propose a discrete time target zones model, taking into account the censured disposition of the exchange rate, whose parameters will be estimated by the FIML method. The settled theoretical model is a simplified version of Dornbusch's (1976) model, applied in a two countries environment. It will be tested into a peseta/deutsche mark exchange rate frame, from june 1989 to december 1998. The period is split in two sub-samples thinking over the enlargement of bands decided in august 1993. The estimation procedure of the model is based on the limited dependent rational expectation technique developed by Pesaran and Ruge-Murcia (1999). The results point out weightly differences between the two considered sample periods and, at least for the first period, doesn't verify the regularities found for other exchange rates in the EMS.