The duration of fixed exchange rate regimes



Figure 2 estimates separate hazard functions and shows that there are pronounced differ-
ences in the shape of the hazard functions depending on country type. Developed economies
exhibit almost no duration dependence. Emerging market economies are characterised by
a higher hazard function with a non-monotonic pattern of duration dependence. Figure 3
presents estimates of the survivor functions and confirms this evidence. A log-rank test of
the equality of survivor functions rejects the null hypothesis at the 1% level.

The bipolar hypothesis of exchange rate regimes claims that in a world of highly inte-
grated financial markets, fixed exchange rate regimes are not sustainable in the long run
and will inevitably collapse at some point. In terms of duration dependence, the hypoth-
esis can be interpreted as positive duration dependence. In other words, the conditional
probability of an exit will not decrease over time. Our results for emerging markets could
suggest that this hypothesis is not supported by the data since a significant portion of
the hazard function is decreasing. However, such a conclusion is doubtful for at least two
reasons. Firstly, we should control for other factors which are likely to affect the viability
of a fixed exchange rate regime, such as the degree of openness of the economy and the
respective stance of fiscal and monetary policies. Secondly, the bipolar hypothesis holds
that countries which are financially integrated will move to the corners, either hard pegs
or floats. Our aggregation of hard and intermediate regimes together allows us to examine
the move from fixing to floating only. Future research should disaggregate the data across
different types of pegging arrangements.

Finally, we examine the hazard function that results when censored observations are
excluded. The sample reduces to 51 observations. Figure 4 separates between types of
countries and shows that both functions indicate (close to) positive duration dependence at
all times, in particular for developed economies. Therefore, excluding censored observations
affects the nature of duration dependence dramatically. Moreover, and not surprisingly,
the estimated values for the hazards increase, reflecting the bias that obtains when the
problem of right-censoring is ignored.

17



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