On Intrinsic Bubbles in the Discrete Time Version of Target Zone Models

Jesús Vázquez, Universidad del País Vasco

Abstract

The intrinsic bubble characterizing the exchange rate dynamics in the discrete time version of target zone models is analyzed. It is found that the intrinsic bubble in the basic target zone model follows in general an explosive first-order autoregressive process. This result explains the U-shaped distribution of the exchange rate in this model. However, the nonlinear and the uniqueness properties so frequently associated with the intrinsic bubble are not robust for an important class of fundamental processes.