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Political and Institutional Factors in Regime Changes in the ERM: An Application of Duration Analysis

International Economics & Finance DEFI Working Paper No. 07-05

41 Pages Posted: 21 Nov 2007  

Simón Sosvilla Rivero

Complutense Institute for International Studies

Francisco Pérez-Bermejo

KPMG-Spain

Date Written: October 2007

Abstract

This paper analyses the functioning of the European Exchange Rate Mechanism (ERM). To that end, we apply duration models to estimate an augmented target-zone model, explicitly incorporating political and institutional factors into the explanation of European exchange rate policies. The estimations are based on quarterly data of eight currencies participating in the ERM, covering the complete history of the European Monetary System. Our results suggest that both economic and political factors are important determinants of the ERM currency policies. Concerning economic factors, the money supply, the real exchange rate, the interest in Germany and the central parity deviation would have negatively affected the duration of a given central parity, while credibility and the price level in Germany would have positively influenced such duration. Regarding political variables, elections, central bank independence and left-wing administrations would have increased the probability of maintaining the current regime, while unstable governments would have been associated with more frequent regime changes. Moreover, we show how the political augmented model outperforms, both in terms of explanatory power and goodness of fit, the model which just incorporates pure economic determinants.

Keywords: Duration analysis, Political variables, Exchange rates, European Monetary System

JEL Classification: C41, D72, F31, F33

Suggested Citation

Sosvilla Rivero, Simón and Pérez-Bermejo, Francisco, Political and Institutional Factors in Regime Changes in the ERM: An Application of Duration Analysis (October 2007). International Economics & Finance DEFI Working Paper No. 07-05. Available at SSRN: https://ssrn.com/abstract=1031608 or http://dx.doi.org/10.2139/ssrn.1031608

Simón Javier Sosvilla Rivero (Contact Author)

Complutense Institute for International Studies ( email )

Carretera de Humera s/n
Madrid, Madrid 28223
Spain
+34913932626 (Phone)

HOME PAGE: http://www.ucm.es/info/ecocuan/ssr/

Francisco Pérez-Bermejo

KPMG-Spain ( email )

Spain
(+34) 91 456 34 00 (Phone)

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