The width of the band and exchange rate mean-reversion: some further ERM-based results

One key prediction of the target zone model is that the exchange rate should be mean-reverting within the band. In this paper we investigate this prediction by examining the time series characteristics of seven currencies participating in the Exchange Rate Mechanism (ERM) of the European Monetary System, both immediately before and after the introduction of wide exchange rate bands in 1993. Using standard univariate unit root tests we find some evidence of mean reversion, and this is much more pronounced using variance ratio test statistics. It turns out that such mean-reversion is as strong for the wide band ERM as for the narrow band ERM