Foreign Exchange Markets' Perceptions of Emu Participation by Finland, France, Italy, and Portugal
27 Pages Posted: 24 Feb 2002
Recent theory on exchange rate dynamics suggests that the mere announcement of regime switching from floating to fixed rates at a given future date triggers a reduction in exchange rate volatility during the interim period. Using a Markov-switching GARCH model, this paper estimates the volatility processes of four EMU exchange rate returns vis-a-vis the German mark using daily data for the time prior to Stage III of EMU. Statistical inference traces the dates at which foreign exchange markets began to incorporate the expected EMU participation of each country into currency pricing. The data exhibits econometric evidence for two distinct country-specific views concerning the ultimate EMU membership. The analysis reveals that in an early phase there was market uncertainty about the actual implementation of Stage III of EMU.
Keywords: EMU, exchange rate policy, volatility, Markov-switching GARCH models
JEL Classification: F31, F33, C51
Suggested Citation: Suggested Citation