Empirical features of the second-generation target zone models: Mean-reverting fundamentals and endogenous devaluation risk

We show that within Bertola and Svensson's second-generation target zone mo del, mean-reverting interventions and endogenous devaluation risk are close ly interrelated. Over the period 1983-93 we analyze the degree of mean reve rsion in the underlying fundamental process as well as the term structure o f interest rate differentials vis-a-vis Germany for six Exchange Rate Mecha nism currencies. For Austria, Denmark and the Netherlands, and for Belgium after 1990 our estimates are broadly in line with the first-generation targ et zone model, whereas those for France and Italy are in accordance with th e model that allows for endogenous devaluation risk. (JEL F31, E43).