Working Paper: NBER ID: w4291
Authors: Zhaohui Chen; Alberto Giovannini
Abstract: The stability of the EMS depends crucially on realignment expectations of the market participants. In this paper we discuss how to measure such expectations and how to relate them to economic fundamentals, central bank reputation, and 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: realignment expectations; European Monetary System; exchange rates; central bank reputation
JEL Codes: F31; E52
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) |
| time since the last realignment (C41) | expected devaluations (F31) |
| Basel-Nyborg agreements (F33) | expected devaluations (F31) |
| past devaluations (F31) | future expectations of devaluation (F31) |