Abstract
This paper analyzes credibility in the Colombian exchange-rate target zone. A model of imperfect credibility, in the spirit of Bertola and Svensson [Bertola, G., Svensson, L., 1993.“Stochastic devaluation risk and the empirical fit of target zone models. Review of Economic Studies 60, 689–712] is derived, and estimated using Colombian data. The main feature of the model is that central-parity depreciation expectations are endogenous with respect to the position of the exchange rate inside the target zone. The Krugman [Krugman, P., 1991. Target zones and exchange rate dynamics. Quarterly Journal of Economics 56 (3), 669–682] perfectly credible setup is a particular case of this general model. A key implication of the model is that depreciation expectations rise rather than fall as the exchange rate approaches the upper band. Using the method of simulated moments (MSM) to estimate the structural parameters underlying the model, I find evidence suggesting that Colombia's exchange-rate target zone is properly described by a model of this nature.
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