Target Zones and Realignment Expectations: The Israeli and Mexican Experience
November 1, 1995
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Summary
This paper studies the Mexican and Israeli experience with a target zone. The first part of the paper develops a model of exchange rate determination under a target zone regime with stochastic realignments, and examines the conditions under which the adoption of the target zone, instead of a fixed exchange rate, reduces the volatility of the interest rate differential. We conclude that if the variance of the expected realignment is sufficiently large, then the target zone will be useful. The second part of the paper is an empirical study that shows that the target zone regime helped reduce interest rate variability in Israel and Mexico by absorbing part of the shocks to the expected realignment with movements of the exchange rate inside the band.
Subject: Conventional peg, Crawling peg, Exchange rate adjustments, Exchange rates, Foreign exchange, Managed exchange rates
Keywords: Conventional peg, Crawling peg, differential variance, Exchange rate adjustments, exchange rate deviation, Exchange rates, interest rate differential, interest rate hedging, interest rate variability, Managed exchange rates, WP
Pages:
20
Volume:
1995
DOI:
Issue:
114
Series:
Working Paper No. 1995/114
Stock No:
WPIEA1141995
ISBN:
9781451853766
ISSN:
1018-5941
Notes
Also published in Staff Papers, Vol. 43, No. 3, September 1996.
