Trigger Strategies and Price Dynamics in Equity and Foreign Exchange Markets

Abstract

Trigger strategists may be defined as actors i r asset markets who buy or sell when the price reaches a pr edeter ml ned level; they include participants in portfolio insurance schemes in equity markets and central banks who i nterverie to defend an exchange rate target zone. This paper presents an approach to rnodel.l ing the effects of trigger strategists, with emphasis on how target zones affect market expectations. It is shown that. commitment to defend a target zone will generate stabilizing expectations within the band, which may generate a "target zone honeymoon". an extended period in which the announcement of a target zone stabilizes exchange rates without any riced for action on the part of authorities. However, an imperfectly credible target zone is vulnerable to crises in which the market tests the authorities' resolve.