Spurious State Dependence, True State Dependence and the Fear of Floating

Abstract

ABSTRACT To better understand the Fear of Floating phenomenon in exchange rate regime evolution, this paper advances the method to identify state dependence and establishes four new findings and explanations. First, the introduction of state dependence into multinomial discrete choice model and calculation of marginal effect corresponding to the parameter estimates are important to correctly explain the exchange rate regimes evolution. Second, both spurious and true state dependence factors can explain the Fear of Floating phenomenon. Third, the estimates of capital account openness are contrary to the prediction of classical theories but are consistent with the Fear of Floating phenomenon in developing economies. Finally, the degree of financial market development cannot affect the regime choices directly, but its non‐linear impact mechanism can further strengthen the explanatory power of this study.