Bayesian Soft Target Zones

Several authors have postulated econometric models for exchange rates restricted to lie within known target zones. However, it is not uncommon to observe exchange rate data with known limits that are not fully `credible'; that is, where some of the observations fall outside the stated range. An empirical model for exchange rates in a soft target zone where there is a controlled probability of the observed rates exceeding the stated limits is developed in this paper. A Bayesian approach is used to analyse the model, which is then demonstrated on Deutschemark-French franc and ECU-French franc exchange rate data.