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Target Zone Interventions and Coordination of Expectations

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Abstract

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.

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Authors and Affiliations

  1. International Business School, Brandeis University, Waltham, Massachusetts, USA

    S. Reitz (Assistant Professor)

  2. Department of Economics, University of Osnabrueck, Osnabrueck, Germany

    F. Westerhoff (Assistant Professor)

  3. RAAD Consult, Muenster, Germany

    C. Wieland (Researcher)

Authors
  1. S. Reitz
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  2. F. Westerhoff
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  3. C. Wieland
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Additional information

The idea of this paper was born during the 2003 Complexity Workshop in Aix-en-Provence and the Viennese Workshop on Optimal Control, Dynamic Games, and Nonlinear Dynamics. The paper was presented at the International Conference on Computing in Economics and Finance in Amsterdam and at the Erich-Schneider research seminar at the University of Kiel. We thank Richard Day, Herbert Dawid, Cars Hommes, Blake LeBaron, Thomas Lux, Erik Mosekilde, Barkley Rosser and Jan Tuinstra for stimulating discussions. Also, we thank two anonymous referees and Christophe Deissenberg for helpful comments.

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Reitz, S., Westerhoff, F. & Wieland, C. Target Zone Interventions and Coordination of Expectations. J Optim Theory Appl 128, 453–467 (2006). https://doi.org/10.1007/s10957-006-9027-6

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  • DOI: https://doi.org/10.1007/s10957-006-9027-6

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