Working Paper: NBER ID: w2459
Authors: Paul R. Krugman
Abstract: Trigger strategist-s may be defined as act-ors in asset markets who buy or sell when the price reaches a predetermined level ; t-hey include participants in portfolio insurance schemes in equity markets and central banks who intervene to defend an exchange rate target zone. This paper presents an approach to modeling the effects of trigger strategists, with emphasis on how target zones affect market expectations. It is shown that a commitment to defend a target zone will generate stabilizing expectations within the band, which may generate a "target zone honeymoon" . an extended period in which the announcement of a target. zone stabilizes exchange rates without any need for action on the part of authorities. However, an imperfectly credible target zone is vulnerable to crises in which the market tests the authorities' resolve.
Keywords: Trigger strategies; Price dynamics; Equity markets; Foreign exchange markets; Target zones
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Commitment to defend a target zone (E61) | Stabilizing expectations within the band (D84) |
| Imperfectly credible target zone (E61) | Vulnerability to crises (H12) |
| Exit of portfolio insurers (G22) | Market crashes (G01) |