Did the EMS Reduce the Cost of Capital?

46 Pages Posted: 22 Feb 2001

See all articles by Enrique Sentana

Enrique Sentana

Centro de Estudios Monetarios y Financieros (CEMFI); Financial Markets Group; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: December 2000

Abstract

We propose a dynamic APT multi-factor model with time-varying volatility for currency, bond and stock returns for ten European countries over the period 1977-1997. We exploit the cross-sectional dimension of the model to construct world portfolios, which, when added to the original list of assets, allow us to develop simple consistent methods of estimation and testing. Our results reject the implicit asset pricing restrictions, and suggest that decreases in idiosyncratic exchange rate risk tend to lower the cost of capital, although the effect is small. Finally, we assess the potential gains from increased stock market integration.

Keywords: Currency risk, European monetary union, financial integration, international asset pricing

JEL Classification: F30, G10

Suggested Citation

Sentana, Enrique, Did the EMS Reduce the Cost of Capital? (December 2000). CEPR Discussion Paper No. 2640. Available at SSRN: https://ssrn.com/abstract=258072

Enrique Sentana (Contact Author)

Centro de Estudios Monetarios y Financieros (CEMFI) ( email )

Casado del Alisal 5
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+34 91 429 0551 (Phone)
+34 91 429 1056 (Fax)

HOME PAGE: http://www.cemfi.es/~sentana/

Financial Markets Group

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Centre for Economic Policy Research (CEPR)

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United Kingdom

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