Stochastic Regime Switching and Stabilizing Policies within Regimes.

This paper describes a class of stochastic stabilizing policies within asset price regimes; that can be easily incorporated into the framework of regime switching recently proposed by K. A. Froot and M. Obstfeld. In contrast to previous treatments of market-driven fundamentals within the regime, authorities stochastically counteract movements in these fundamentals before asset prices reach boundary points. This paper describes how the stabilizing intra-regime intervention policies can be used to characterize the behaviour of monetary authorities before fixing an exchange rate, as in the cases studied by R. P. Flood and P. Garber. An intervention policy within target zone bands consistent with empirical evidence is also a member of this class of policies. Furthermore, the stylized features of these intervention policies may be matched to actual data in a natural way. Copyright @ 1996 by John Wiley & Sons, Ltd. All rights reserved.