Target Zone Interventions and Coordination of Expectations
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- Reitz, S., Westerhoff, F. & Wieland, C. J Optim Theory Appl (2006) 128: 453. doi:10.1007/s10957-006-9027-6
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Foreign exchange markets display regularly severe bubbles. This paper explores whether or not the so-called target zone interventions are an effective tool for central banks to stabilize the exchange rate. We define such intervention operations as buying/selling an undervalued/overvalued currency when the distance between the exchange rate and its fundamental value exceeds a critical threshold value. On the basis of a nonlinear empirical exchange rate model with chartists and fundamentalists, we find that not only target zone interventions have the power to reduce misalignments but also to earn profits.