This paper proposes a path-dependent approach for estimating maximum appreciations of the renminbi expected by the market based on first-passage-time distributions. Using market data of the renminbi spot exchange rates, non-deliverable forward rates and currency option prices from 21 July 2005 (the reform of the exchange rate regime) to 28 February 2008 for model parameters, the maximum appreciations of the renminbi estimated under the proposed approach show that the market expected another large movement of the exchange rate during the 14 months after the reform. Subsequently, the few occasions of appreciations beyond the expected maximums coincided with the trade-related issues and speculations of greater momentum of appreciation allowed by the authorities. The PBoC's measures were however largely incorporated into the derivatives' prices. The proposed approach can be used to gauge the range of appreciations of the renminbi anticipated in the market and to identify any exchange rate movements beyond market expectations.

On 21 July 2005 China adopted an undisclosed basket exchange rate regime. We formally assess and envisage the gradual evolution of the renminbi over time. We utilize nonlinear dependencies in the renminbi exchange rate and describe the smooth transition of the renminbi/U.S. dollar (RMB/USD) exchange rate using the family of time-varying autoregressive (TV-AR) models. The results indicate that the forward-looking nonlinear model adequately depicts the gradual reform process underlying the new RMB exchange rate regime.