Central Bank Intervention Under Target Zones: the Portuguese Escudo in the ERM.- Jorge Braga de Macedo, Luís C. Nunes, Luís Brites-Pereira

Abstract

For Portugal, the transition to the Euro began in Setember 1989 and featured three successive institutional arrangements related to the Exchange Rate Mechanisme of the European Monetary Systems: shadowing it: belonging to it with 6% and then with 15% fluctuation bands. Using daily data, we study how the degree  of neam reversion of the exchange rate and central bank intervention reflect the change in economic regime towards stability and convertibility. Our Markov regime-switching framework with an EGARCH specification allows for devitions from central parity and intervention to affect the neam, the conditional variance and the state transition probabilities in the different policy regimes. Mean reversion is significant even when volatility is high in ERM-6, unlike central bank intervention, wich almost disappears in ERM-15. Intervention affects the mean and the variance of the exchange rate when volatility is low, and the variance in ERM-S, even when volatility is high.

Keywords: Central Bank intervention, target zones, exchange rate mechanism, regime-switching