Finance Working Papers,
University of Aarhus, Aarhus School of Business, Department of Business Studies

Abstract: This paper presents an analysis of the basis target zone model, using data from three core EMS members. Recent research har argued that the model may not perform empirically as bad as previous investigation have suggested. In order to investigate this point, we first estimate the model by a nonparametric density matching procedure, and extract the implied drift and diffusion function for the exchange rate process. This allows us to view the target zone model essentially as a time series model, with a clearly defined diffusion process governing target zone exchange rates. We then compare the implied drift and diffusion function with their nonparametric estimates. We conclude that exchange rates under consideration are actually more mean reverting than the target zone model predicts. When very close to the intervention limits, the data are far from the target zone model's implications. We perform a Monte Carlo study, which documents that our methodology is indeed able to capture the potential non-linearities in the drift and diffusion predicted by the theory.

Keywords: Targets zones; Diffusion process; Nonparametric estimation

33 pages, August 22, 2000

Full text files

D00_13.PDF  

Download statistics

• University of Aarhus, Aarhus School of Business, Department of Business Studies
• Home page for this series

Questions (including download problems) about the papers in this series should be directed to Helle Vinbaek Stenholt ()
Report other problems with accessing this service to Sune Karlsson ().

RePEc:hhb:aarfin:2000_013This page generated on 2024-09-13 22:19:13.