Identifying the weights in exchange market pressure

Exchange market pressure (EMP) measures the pressure on a currency to depreciate, and it is particularly relevant in crisis periods. EMP adds to the actual depreciation a weighted combination of policy instruments used to ward off depreciation, such as interest rates and foreign exchange interventions, where the weights are their effectiveness. The key difficulty in the literature is how to identify these weights. We introduce a novel method to do so. It exploits the persistence of pressure and adds instruments based on currency crisis theories, leading to a simple IV regression to estimate the weights.