Working Paper: CEPR ID: DP790
Authors: Zhaohui Chen; Alberto Giovannini
Abstract: The stability of the EMS depends crucially on the realignment expectations of market participants. In this paper we discuss how to measure such expectations and how to relate them to economic fundamentals, central bank reputation, and the institutional arrangements of the EMS. We find the following empirical regularities for FF/DM and IL/DM exchange rates: (1) expected devaluations are positively related to the current exchange rate deviation from the central parity; (2) expected devaluations are negatively related to the length of time since last realignment in the short and medium run; (3) the Basle-Nyborg agreements seem to have a stabilizing effect for both currencies examined, albeit through different channels; (4) large revaluation expectations occur immediately after devaluations. (1) and (4) are not inconsistent with the hypothesis of `over-speculation' or market inefficiency.
Keywords: EMS; realignment; exchange rates; Basle-Nyborg agreements
JEL Codes: F31; F33; E58; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| current exchange rate deviation from the central parity (F31) | expected devaluations (F31) |
| length of time since the last realignment (C41) | expected devaluations (F31) |
| Basle-Nyborg agreements (F33) | realignment expectations (D84) |
| past devaluations (F31) | current market expectations (D84) |