An Arbitrage Free Trilateral Target Zone Model

Bjørn N. Jørgensen; Hans Ole Mikkelsen

doi:10.1016/0261-5606(95)00050-X

An Arbitrage Free Trilateral Target Zone Model

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Abstract

This paper proposes an arbitrage free trilateral model of a credible target zone regime with bands on each bilateral exchange rate. The no arbitrage condition reduces the system to only two dimensions. Any two rates must obey their own boundaries but, in addition, the free rein for movements is restricted by the band of the redundant rate. Therefore, target zone models defined in bilateral settings do not apply to general systems with a cobweb of bilateral bands, such as the European Monetary System. Since the model has no known analytical solution it is estimated by the method of simulated moments.

Original language	English
Journal	Journal of International Money and Finance
Volume	15
Issue number	1
Pages (from-to)	117-134
Number of pages	18
ISSN	0261-5606
DOIs	https://doi.org/10.1016/0261-5606(95)00050-X
Publication status	Published - 1996
Externally published	Yes

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title = "An Arbitrage Free Trilateral Target Zone Model",

abstract = "This paper proposes an arbitrage free trilateral model of a credible target zone regime with bands on each bilateral exchange rate. The no arbitrage condition reduces the system to only two dimensions. Any two rates must obey their own boundaries but, in addition, the free rein for movements is restricted by the band of the redundant rate. Therefore, target zone models defined in bilateral settings do not apply to general systems with a cobweb of bilateral bands, such as the European Monetary System. Since the model has no known analytical solution it is estimated by the method of simulated moments.",

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year = "1996",

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AU - Mikkelsen, Hans Ole

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N2 - This paper proposes an arbitrage free trilateral model of a credible target zone regime with bands on each bilateral exchange rate. The no arbitrage condition reduces the system to only two dimensions. Any two rates must obey their own boundaries but, in addition, the free rein for movements is restricted by the band of the redundant rate. Therefore, target zone models defined in bilateral settings do not apply to general systems with a cobweb of bilateral bands, such as the European Monetary System. Since the model has no known analytical solution it is estimated by the method of simulated moments.

AB - This paper proposes an arbitrage free trilateral model of a credible target zone regime with bands on each bilateral exchange rate. The no arbitrage condition reduces the system to only two dimensions. Any two rates must obey their own boundaries but, in addition, the free rein for movements is restricted by the band of the redundant rate. Therefore, target zone models defined in bilateral settings do not apply to general systems with a cobweb of bilateral bands, such as the European Monetary System. Since the model has no known analytical solution it is estimated by the method of simulated moments.

U2 - 10.1016/0261-5606(95)00050-X

DO - 10.1016/0261-5606(95)00050-X

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EP - 134

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