ADJUSTABLE PEGS VS SINGLE CURRENCIES - HOW VALUABLE IS THE OPTION TO REALIGN

One cost involved in going from an adjustable peg exchange rate regime to a system of irrevocably fixed exchange rates, by the introduction of a single currency, is that the participating members will forego th e option to realign that is inherent in any adjustable peg system. Thi s issue is of relevance in Europe, where the introduction of a Europea n Monetary Union and a single currency is actively contemplated. This paper values the option to realign using recently developed methods of optimal regulation of Brownian motion, as exposited by Dixit (1991).