Constant elasticity of variance models with target zones

In this paper, we study a reflected constant elasticity of variance (RCEV) process with two-sided reflecting barriers for modeling the dynamics of a foreign exchange rate in a target zone. We derive a closed form expression for the transition density by using the spectral expansion method. Monte Carlo simulation shows that our method is accurate and efficient when the results are applied to compute the expected value of the process. Finally, we illustrate that ignoring target zones in the CEV model may lead to significant computational errors. •The dynamics of exchange rates in target zones is modeled by the RCEV process.•Transition density of the process is derived by spectral expansion method.•Monte Carlo simulation shows that our method is accurate and efficient.•Ignoring target zones in the CEV model may lead to significant computational errors.