1 Introduction and motivation
The widespread wave of currency and financial crises that has affected developed and
emerging market economies during the last decade has brought the issue of optimal ex-
change rate policy back to the forefront of the research agenda in international macroeco-
nomics. In particular, much attention has been given to exits from fixed to flexible exchange
rate regimes, their nature, as well as their macroeconomic, financial and institutional de-
terminants. Most empirical studies make use of discrete-choice econometric specifications,
whereby the dependent variable takes a value of unity whenever an exit occurs, and zero
otherwise.
This paper is about the survival of fixed exchange rate regimes. We argue that the
time spent within a given regime is likely to determine the probability that a regime will
end. Klein and Marion (1997) and Duttagupta and Otker-Robe (2003) introduce duration
as an explanatory variable in a logit specification. The statistical significance of the at-
tached regression coefficient indicates that time matters, and its sign whether it contributes
positively or negatively to the probability of an exit. This approach remains limited on
conceptual and analytical grounds and a duration model will be more appropriate.
At a conceptual level duration analysis deals directly with the conditional probability of
an event taking place, rather than with its unconditional probability. The key question is:
”What is the probability that a given regime will end at time t + 1, given that it has lasted
up to time t?” The natural way of thinking about the probability that a regime will end at
some point in the future when we believe that the time spent within the regime affects this
same probability is in terms of successive rounds. Suppose that a regime starts in period
1. In period 1, we will consider the probability that the regime will end in period 2. In
period 2, we will consider the probability that the regime will end in period 3, conditional
on the fact that the regime has lasted up to period 2. In period t > 2, we will consider the
probability that the regime will end in period t + 1, conditional on the fact that the regime
has lasted up to period t. If we believe that duration is important then the probability of
an exit at some point in the future is naturally considered as a sequence of simpler events.