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Exchange Rate Dynamics Under Stochastic Regime Shifts: A Unified Approach

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  • Froot, Kenneth
  • Obstfeld, Maurice

Abstract

Simple techniques of regulated Brownian motion are used to analyse the behaviour of the exchange rate when official policy reaction functions are subject to future stochastic changes. We examine exchange rate dynamics in cases where the authorities promise (i) to confine a floating rate within a predetermined range, (ii) to peg the currency once it reaches a predetermined future level, and (iii) to unify a system of dual exchange rates. Similarities between these and several related examples of regime switching are stressed. We also discuss how stochastic regime changes can affect some standard statistical tests of hypotheses about exchange rates.

Suggested Citation

  • Froot, Kenneth & Obstfeld, Maurice, 1991. "Exchange Rate Dynamics Under Stochastic Regime Shifts: A Unified Approach," CEPR Discussion Papers 522, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:522
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    1. Paul R. Krugman, 1988. "Target Zones and Exchange Rate Dynamics," NBER Working Papers 2481, National Bureau of Economic Research, Inc.
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