FUNDAMENTALS AND DEVALUATION EXPECTATIONS IN TARGET ZONES - SOME NEW EVIDENCE FROM THE ERM

The credibility of exchange rate target zones for four EMS countries f or the period March 1979-September 1992 is examined. Existing methods by Svensson, Edin and Vredin, typically applied to data from the Nordi c countries, are considered. On balance, the method suggested by Edin and Vredin provides somewhat better estimates of devaluation probabili ties than either of Svensson's methods. While all methods produce reas onably good estimates of the expected size of devaluations, they did n ot predict the September 1992 EMS crisis. However, we find that electo ral and other institutional variables improve estimates of devaluation expectations.