TARGET ZONES AND FORWARD RATES IN A MODEL WITH REPEATED REALIGNMENTS

This paper studies the term structure of forward premia in a target zone with imperfect credibility. The relationship between spot and forward exchange rates, which reflects the possibility of realignments of the band, is studied for various intervention policies with different degrees of credibility. Forward market data is used to estimate the implied credibility of the French/German target zone during the EMS. Parameter estimates accord with the experience of the FF/DM exchange rate during the 1980s. Although spot exchange rates display little sensitivity to anticipated intervention, forward data can be used to detect the effects of intervention on exchange rate dynamics.