The lifetime of a unilateral target zone: some extended results

Abstract

In Dumas and Svensson (Journal of International Economics 36 (1994) 467) the lifetime of a Krugman (Quarterly Journal of Economics 106 (1991) 669-682) type target zone model is found to be extremely long. This paper shows that the lifetime of the identical target zone regime can be much lower when real disturbances occur. In particular, the mean lifetime is found to be very low when real disturbances occur and the real exchange rate elasticity of the demand for domestic goods is very low. It is also shown that allowing for monetary disturbances to have real effects has very little effect on the lifetime. The results indicate the conditions under which real disturbances might trigger currency crises. 

Limited Reserves and the Optimal Width of an Exchange Rate Target Zone

“…In particular if η is low the lifetime is much lower in the case of a real drift than in the case of a velocity drift. The surprise supply function used in this paper is an improvement on, and strengthens the results contained in Broome (2001). This improvement means that the slope of the supply function has no significant effect on the lifetime.…”

“…According to (15) the bandwidth is narrowed only if the fall in the mean variances discounted over the expected lifetime, exceeds the discounted increase in the mean variances caused by the expectation of an earlier transition to the floating regime. The lifetime is calculated following the fundamentals based approach used in Dumas and Svensson (1994) and Broome (2001). This requires assuming that implicit constraints prevent the exclusive focus of monetary policy on the defence of the target zone, or equivalently the stock of foreign reserves is not infinite.…”

“…The lifetime can then be calculated as the first passage time of initial reserves to a critical lower bound that triggers the collapse of the target zone. The difference between (15) and Broome (2001) is that the lifetime is optimally chosen. Solving (15) requires the policymaker to choose both the optimal bandwidth and the lifetime.…”

A Cautionary Note on the Put-Call Parity under an Asset Pricing Model with a Lower Reflecting Barrier

“…Swiss Journal of Economics and Statistics, 2015, Vol. 151 313 Dumas and Svensson (1994) and Broome (2001) analyze the expected lifetime of unilateral target zones and the factors that determine their survival time. It may be interesting to analyze the recent Swiss experience, which may add new insights to this strand of literature.…”

Forward-rate target zones and exchange rate dynamics

“…2481, 1988 It has been shown that there exists a negative trade-off between the exchange rate band and the interest rate differential's instantaneous variability: a narrow target zone gives rise to a large magnitude of the instantaneous variability of the interest rate differential; see Svensson (1989Svensson ( , 1991. 4 See, for instance, Flood and Garber (1991), Froot and Obstfeld (1991), Miller and Weller (1991), Krugman and Rotemberg (1991), Delgado and Dumas (1992), Svensson (1991Svensson ( , 1992, Bertola and Caballero (1992a,b), Dumas and Svensson (1994), Sutherland (1995), Miller and Zhang (1996), Serrat (2000), and Broome (2001). All these target-zone models generate randomness from a Wiener process, either with drift or without.…”