Krugman (1991)'s target zone model has become the reference of a large part of this literature. Despite its simplicity and elegance, empirical evidence has been lacking. Deriving from Krugman's model analytical expressions for the conditional volatility and density distribution close to the...

Time series evidence on exchange rates has been unable to reject the random walk hypothesis. A simple structural model that accounts for target zone nonlinearities provides conclusive evidence of mean reversion in EMS exchange rates.