Simulating Exchange Rates with a Target-Zone Intervention Model

Summary

The document presents a discrete-time stochastic model for an exchange rate within a target zone. Its components include a drift linked to the interest-rate differential, a reference rate, a coefficient representing central-bank leaning against exchange-rate movements, and a white-noise shock. It also gives boundary rules that reflect values back when the simulated rate crosses the upper or lower band.

The author wants to generate a year of daily paths for Morocco and asks whether Monte Carlo simulation is appropriate and how to use it. The text supplies a model specification and an intended application, but no parameter estimates, calibration procedure, simulation results, or answer. Consequently, it does not show that the proposed dynamics fit Morocco or explain how the boundary rule should be implemented in practice. Any use for forecasting would depend on validating the intervention assumptions and estimating the drift, noise, reference level, and bands from relevant data.

Key ideas

• The proposed exchange-rate process combines drift, a reference level, intervention strength, and random shocks.
• The model describes central-bank intervention as leaning against movements away from a target rate.
• Values beyond either target-zone boundary are reflected back according to stated rules.
• Monte Carlo paths are suggested as a possible way to represent future daily exchange-rate scenarios, but no simulation method or calibration is provided.

Tags

# Model for target zone exchange rates


# Model for target zone exchange rates












I just found a stochastic model for target zone exchange rates

$x_{t+1}=x_t+k+r(x_t-y)+ \tilde{\epsilon}$

where k is a drift term so equal $r-r_f$

r is lean againt the wind coefficient that characterise the central bank intervention

y is the reference exchange rate or the desired exchange rate

$\tilde{\epsilon}$ is a whitenoise term

but this process is subject to some conditions

-if $x_{t+1} > U$ then the value of the exchange rate would be $2 x_{t+1}-U$ (where U is the upper band)

-if $x_{t+1} < L$ then the value of the exchange rate would be $2 x_{t+1}-L$ (where L = lowerband)

My problem is that i want to use this process for the Moroccan case to generate a 1 year path of daily exchange rate that could be the probable path

Should i use the monte carlo simulation ? and how could i use it

thanks in advance

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.