This paper distinguishes between some obvious necessary and sufficient conditions for adopting the target zone proposal as a means of improving macroeconomic performance. The necessary conditions may be satisfied fairly easily, but it is a good deal more difficult to design a targeting system...

The foreign exchange risk premium in an exchange rate target-zone regime with devaluation/realignment risks is derived. In contrast to previous literature, the exchange rate's heteroscedasticity within the band, as well as a separate devaluation/realignment risk, is taken into account. The risk...

Recently developed models of exchange rate dynamics emphasize the expectational effects of infrequent intervention. This paper proposes a stylized probabilistic framework in which such effects can be studied along with realistic concerns about the sustainability of the intervention policy. In...

Under the assumption of no arbitrage, exchange rate target-zone credibility is tested by whether domestic interest rates fall within `rate-of-return bands' between the maximum and minimum home-currency rate of return on a foreign investment in the absence of a devaluation. Under the assumption...

Many recent papers suggest that the basic flex-price target zone model does not perform well empirically. This paper derives some of the testable implications of a sticky-price target zone model in order to determine whether the assumption of perfect price flexibility explains the empirical...

In our model, an exchange rate fluctuates between given boundaries for random lengths of time and jumps discretely when devaluations occur. We provide explicit solutions for the stochastic processes followed by the exchange rate and by the expected rate of depreciation when the likelihood and...

The desire to avoid speculative runs on currencies appears to be one of the main reasons leading policy-makers to impose currency bands, but the standard analysis of target zones rules out any speculative inefficiencies by assumption. As an alternative we first present simple models of excess...

In credible target zone regimes, exchange rates should, according to Krugman's 1991 theory, spend a disproportionate amount of time near the edges of the fluctuation band. The major application of this theory has been to the European Monetary System (EMS), with several authors reporting that...

In this paper I examine issues of optimal stabilization in two types of world economy, a competitive one where all countries are small, and one where there is a Stackelberg leader. The focus is on the 1985 target zones proposal of Williamson, according to which there should be a periodic fixing...

The recent theory of exchange rate dynamics within a target zone holds that exchange rates under a currency band are less responsive to fundamental shocks than exchange rates under a free float, provided that the intervention rules of the Central Bank(s) are common knowledge. These results are...