A Model of Stochastic Process Switching / Robert P. Flood, Peter M. Garber.

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Flood, Robert P

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w0626.Publication details: Cambridge, Mass. National Bureau of Economic Research 1981.Description: 1 online resource: illustrations (black and white)Online resources:

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Abstract: In this paper we develop a rational expectations exchange rate model which is capable of confronting explicitly agents' beliefs about a future switch in exogenous driving processes. In our set-up the agents know with certainty both the initial exogenous process and the new process to be adopted when the switch occurs. However, they do not know with certainty the timing of future switch as it depends on the path followed by the (stochastic) exchange rate. The model is discussed in terms of the British return to pre-war parity, in 1925. However, our results are applicable to a variety of situations where process switching depends on the motion of a key endogenous variable.

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Previous	nber w0623 Wage-Employment Contracts (Replaced by W0675) /	nber w0624 An Intertemporal Analysis of Taxation and Work Disincentives: An Analysis of the Denver Income Maintenance Experiment /	nber w0625 Explanations of Exchange Rate Volatility and Other Empirical Regularities in Some Popular Models of the Foreign Exchange Market /	nber w0626 A Model of Stochastic Process Switching /	nber w0627 The Adequacy of Savings /	nber w0628 Trade Policy and Import Competition under Fluctuating Prices /	nber w0629 The Real Price of Oil and the 1970s World Inflation /	Next

February 1981.

In this paper we develop a rational expectations exchange rate model which is capable of confronting explicitly agents' beliefs about a future switch in exogenous driving processes. In our set-up the agents know with certainty both the initial exogenous process and the new process to be adopted when the switch occurs. However, they do not know with certainty the timing of future switch as it depends on the path followed by the (stochastic) exchange rate. The model is discussed in terms of the British return to pre-war parity, in 1925. However, our results are applicable to a variety of situations where process switching depends on the motion of a key endogenous variable.