Inside and Outside the Band Exchange Rate Fluctuations for Brazil

This paper analyzes the empirical fit of a new approach to exchange rate target zones. Unlike most of the literature on target zones, we use an estimation procedure that takes explicitly into account the band constraints, and hence their effect on the expectations of agents. Crucially, we do not impose Uncovered Interest Parity to assess realignment expectations. Rather than a point estimate of the future exchange rate, we estimate the entire range of realizations anticipated by the markets, and the probability attributed to each range. We examine high-frequency Brazilian post-stabilization (stable) data in allowing for both realignment jumps and within-the-band jumps. Knowledge of the exchange rate distribution can be relevant not only to the private sector for the management of currency risk, but also to policymakers as a source of prompt market feedback to policy changes or other political and economic shocks.Exchange rates; Target zones; Brazil