Target zone models with stochastic realignments: an econometric evaluation

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This paper provides empirical support for the second generation of target zone models with stochastic devaluation risk. I propose a simple non-linear framework with a time varying probability of exchange rate realignment. This model nests alternatives (i) with no devaluation risk; (ii) with constant devaluation risk; and (iii) the random walk. I reject these three in favor of a stochastic realignment model where devaluation risk varies with economic fundamentals. The model predicts 13 of 17 realignments for the Franc and Lira, including an out-of-sample episode in August 1993.

Original languageEnglish (US)
Pages (from-to)641-657
Number of pages17
JournalJournal of International Money and Finance
Issue number5
Publication statusPublished - Jan 1 1995


All Science Journal Classification (ASJC) codes

  • Finance
  • Economics and Econometrics

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