The pair was resumed to currency band target zone after the removal of the policy EURCHF 1.2000 in 2015. However, the price movement is very slow and to put the pair less fesible to trade in the form of time frame. Nonetheless, potential profit could be printed.
EURCHF: Informal one-sided target zone model and the Swiss Franc
By Yu-Fu Chen, Michael Funke and Richhild Moessner
IMF-BIS Working Papers
Monetary and Economic Department
This paper develops a new theoretical model with an asymmetric informal (unofficial) one-sided target zone, using Switzerland as an example. The model incorporates the notion that a target zone can be seen as a partially credible commitment device. Analytically, the modelling approach lies at the crossroads of the literature on exchange rate target zones originated by Krugman (1991) and that on intervention in the foreign exchange market. With the aim of parsimony in mind, but also with the aim of ensuring a fair degree of reality, we extend and generalize the standard target zone model by introducing perceived uncertainty about the lower band following the removal of the minimum exchange rate of CHF 1.20 per euro in January 2015. We find that informal soft edge target zone bands lead to weaker honeymoon effects, wider target zone ranges and higher exchange rate than formal target zone bands. As discussed in Section 3, the honeymoon effect stabilises the exchange rate relative to its fundamentals. It refers to the phenomenon that, if the Swiss franc is close to the informal floor, the probability increases that the Swiss franc will hit the floor, which leads to perceived interventions by the . Consequently, the probability that the Swiss franc will depreciate is higher than the probability that it will appreciate further, and therefore the Swiss franc will appreciate less than is given by the fundamentals alone. Our model suggests that it would be beneficial for exchange rate policy intentions to be stated clearly to reduce misinterpretation, in order to anchor exchange rate expectations and reduce exchange rate . However, transparency about foreign exchange intervention and exchange rate policy may also have adverse effects, which would need to be weighed against the potential benefits of transparency about exchange rate policy and intervention implied by our model. Moreover, there may be uncertainty and misperceptions about fundamentals, which are not modelled here. We also study how exchange rate dynamics can be characterized in models in which financial markets are aware of occasional changes in the policy regime. We show that expected changes in the central bank’s exchange rate policy may lead to exchange rate oscillations, providing an additional source of exchange rate . To capture this effect, it is important to take into account the possibility of regime changes in exchange rate policy. The ability of the univariate Markov-switching model to generate non-trivial connections between the dynamics of the exchange rate in both regimes represents a promising feature and opens the door to study the link between exchange rate uncertainty and real activity in a multivariate setting. It is clear that target zone regimes vary from one country to another and within countries over time. Our extension of the original Krugman model is, therefore, only one example of how such a regime might work. Exchange rate economics is an exceptionally exciting subject. We hope that the model presented above can contribute to it.