Exchange rate dynamics in anticipation of time-contingent regime switching: modelling the effects of a possible delay
Wilfling Bernd, Maennig Wolfgang
Abstract
The procedure of fixing a currently floating exchange rate at a given (and publicly announced) future date has a broad range of applications. Based on a (continuous-time) monetary exchange rate model with flexible prices, this paper analyzes exchange rate dynamics during the transition from floating to fixed rates in a situation in which market participants are uncertain about adherence to the fixing date and in which they take account of a possible delay in the regime switch. The closed-form solutions derived here allow us to quantify announcement effects as well as effects on the exchange rate variance caused by news that significantly changes the market’s assessment of uncertainty.
Keywords
Exchange rate regime switches; stochastic processes; mixtures of distributions; uncertainty