Explaining the early years of the euro exchange rate: An episode of learning about a new central bank
AbstractMany observers were surprised by the depreciation of the euro after its launch in 1999. Handicapped by a short sample, explanations tended to appeal to anecdotes and lessons learned from the experiences of other currencies. Now sample sizes are just becoming large enough to permit reasonable empirical analyses. This paper begins with a theoretical model of pre- and post-euro foreign exchange trading that generates three possible causes of euro depreciation: a reduction in hedging opportunities due to the elimination of the legacy currencies, asymmetric information due to some traders having superior information regarding shocks to the euro exchange rate, and policy uncertainty on the part of the ECB. One empirical implication of the model is that higher transaction costs associated with the euro than the German mark may have contributed to euro depreciation. However, empirical evidence on percentage spreads tends to reject the hypothesis that percentage spreads were larger on the euro than the mark for all but the first few months. This seems like an unlikely candidate to explain euro depreciation over the prolonged period observed. Reviewing evidence on market dynamics around ECB, Bundesbank, and Federal Reserve meetings, there is no evidence suggesting that the market is "front running" in a different manner than the other central banks. However, we do find empirical support for the euro exchange rate to be affected by learning. By focusing on euro-area inflation as the key fundamental, the model is structured toward the dynamics of learning about ECB policy with regard to inflation. While a stated target inflation rate of 2 percent existed, it may be that market participants had to be convinced that the ECB would, indeed, generate low and stable inflation. The theory motivates an empirical model of Bayesian updating related to market participants learning about the underlying inflation process under the ECB regime. With a prior distribution drawn from t
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Bibliographic InfoArticle provided by Elsevier in its journal European Economic Review.
Volume (Year): 51 (2007)
Issue (Month): 3 (April)
Contact details of provider:
Web page: http://www.elsevier.com/locate/eer
Other versions of this item:
- Manuel Gomez & Michael Melvin, . "Explaining the Early Years of the Euro Exchange Rate: an episode of learning about a new central bank," Working Papers 2179608, Department of Economics, W. P. Carey School of Business, Arizona State University.
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Bollerslev, Tim & Melvin, Michael, 1994. "Bid--ask spreads and volatility in the foreign exchange market : An empirical analysis," Journal of International Economics, Elsevier, vol. 36(3-4), pages 355-372, May.
- Hans-Werner Sinn & Frank Westermann, 2001. "Why Has the Euro Been Falling?," CESifo Working Paper Series 493, CESifo Group Munich.
- Lewis, Karen K, 1989. "Changing Beliefs and Systematic Rational Forecast Errors with Evidence from Foreign Exchange," American Economic Review, American Economic Association, vol. 79(4), pages 621-36, September.
- Hau, Harald & Killeen, William & Moore, Michael, 2002. "The euro as an international currency: explaining puzzling first evidence from the foreign exchange markets," Journal of International Money and Finance, Elsevier, vol. 21(3), pages 351-383, June.
- Hartmann,Philipp, 1998.
"Currency Competition and Foreign Exchange Markets,"
Cambridge University Press, number 9780521632737.
- Bossaerts, Peter & Hillion, Pierre, 1991. "Market Microstructure Effects of Government Intervention in the Foreign Exchange Market," Review of Financial Studies, Society for Financial Studies, vol. 4(3), pages 513-41.
- Chib, Siddhartha, 1998. "Estimation and comparison of multiple change-point models," Journal of Econometrics, Elsevier, vol. 86(2), pages 221-241, June.
- Minoas Koukouritakis & Nikolaos Giannellis, .
"Behavioural Equilibrium Exchange Rate and Total Misalignment: Evidence from the Euro Exchange Rate,"
0901, University of Crete, Department of Economics.
- Nikolaos Giannellis & Minoas Koukouritakis, 2011. "Behavioural equilibrium exchange rate and total misalignment: evidence from the euro exchange rate," Empirica, Springer, vol. 38(4), pages 555-578, November.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei).
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.