Exchange Rate Target Zones and Stock Price Volatility.

We show how agents rational expectations regarding the state-contingent activation of policy instruments do not only impact the asset price it is designed to affect but spill over onto the entire range of asset prices in an economy. We present an application to exchange rate target zones as a state-contingent instrument for monetary policy. In particular we find that any explicit credible target zone for the exchange rate is associated with an implicit target zone for the stock price where the non-linearity of the exchange rate function translates into a corresponding stabilizing non-linearity of the stock price path. Copyright @ 1999 by John Wiley & Sons, Ltd. All rights reserved.