Exchange rate dynamics under state-contingent stochastic process switching |
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Authors: | Anna Naszodi |
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Institution: | Magyar Nemzeti Bank (The Central Bank of Hungary), Szabadsag ter 8-9, Budapest 1054, Hungary |
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Abstract: | This paper offers a closed-form solution of a process switching problem, i.e., switching the exchange rate regime from free-floating to a completely fixed one. An example of such regime change is the adoption of the Euro. In contrast to previous studies on the subject, this paper analyzes a specific case when foreign exchange market participants consider both the Euro locking rate and locking date as uncertain. Preceding the locking, the exchange rate is determined by three factors: fundamental, market expectations for the Euro locking rate, and date. The model is used to examine the conditions under which the exchange rate volatility is mitigated by the prospect of locking. |
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Keywords: | F31 F36 G13 |
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