The Term Structure of Interest Differentials in a Target Zone with Time-varying Devaluation Risk.

We extend Svensson's (1991b) analysis of the term structure of interest rate differentials in a target zone. First, the model includes a time-varying devaluation risk, and second, we analyse the term structure of interest differentials vis-a-vis Germany in five countries: Belgium, Denmark, France, Italy and the Netherlands. In our sample, 1983-1993, we differentiate between stable and unstable periods. The findings for Denmark and the Netherlands, and for Belgium in the relatively stable period are broadly in line with Svensson's theory, whereas the other results are more in accordance with the model that allows for a time-varying devaluation risk. (J.E.L. E43, F31). [ABSTRACT FROM AUTHOR]