AN EMS TARGET ZONE MODEL IN DISCRETE-TIME

The discrete time analogue of the continuous time Krugman target zone model is developed in order to capture the typical volatility clusters and fat-tailed distributed innovations of exchange rates, It is shown that under these more general stochastic conditions the S-shaped rela tion between exchange rate and fundamentals is preserved, but is less pronounced. The model is tested for its S-shape and stochastic propert ies. Two clearly distinct sets of EMS currencies are detected on the b asis of the curvature features, One-step-ahead realignment probabiliti es are used as an alternative evaluation method. (C) 1998 John Wiley & Sons, Ltd.