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I just found a stochastic model for target zone exchange rates

$x_{t+1}=x_t+k+r(x_t-y)+ \tilde{\epsilon}$

where k is a drift term so equal $r-r_f$

r is lean againt the wind coefficient that characterise the central bank intervention

y is the reference exchange rate or the desired exchange rate

$\tilde{\epsilon}$ is a whitenoise term

but this process is subject to some conditions

-if $x_{t+1} > U$ then the value of the exchange rate would be $2 x_{t+1}-U$ (where U is the upper band)

-if $x_{t+1} < L$ then the value of the exchange rate would be $2 x_{t+1}-L$ (where L = lowerband)

My problem is that i want to use this process for the Moroccan case to generate a 1 year path of daily exchange rate that could be the probable path

Should i use the monte carlo simulation ? and how could i use it

thanks in advance

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  • $\begingroup$ I wanna use this to stress test the value of the portfolio after the introduction of the floating exchnage rate in target zone $\endgroup$ – SquaredCircle Apr 25 '17 at 18:14

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