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Towards European monetary integration - the evolution of currency risk premium as a measure for monetary convergence prior to the implementation of currency unions

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Author Info
Fernando González () (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany)
Simo Launonen () (SEB Merchant Banking, Unioninkatu 30, P. O. Box 630, 00101 Helsinki, Finland)
Abstract

We assess monetary convergence preceding the implementation of the EuropeanMonetary Union (EMU) through Kalman filtering estimates of the risk premium of eleven forward exchange rates of European and non-European currencies. Since all participating currencies are in effect identical from inception of a currency union, the convergence process to such an identical status should be reflected in the participating currencies' risk premiums prior to monetary union implementation. Starting from this assumption, we show the paths followed by the participating currencies towards monetary union. We find that the co-movements of risk premiums among the preceding European Monetary System (EMS) currencies differ across time periods but display a tendency to convergence to the German mark’s risk premium up to EMU implementation. The paper also shows a clear pattern of asymmetry of the participating currencies in relation to the German mark.

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Paper provided by European Central Bank in its series Working Paper Series with number 569.

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Length: 39 pages
Date of creation: Dec 2005
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Handle: RePEc:ecb:ecbwps:20050569

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Related research
Keywords: Currency unions European Monetary Union foreign exchange risk premium.

Find related papers by JEL classification:
F02 - International Economics - - General - - - International Economic Order; Noneconomic International Organizations;; Economic Integration and Globalization: General
F31 - International Economics - - International Finance - - - Foreign Exchange
F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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    Other versions:
  2. Hassapis, Christis & Pittis, Nikitas & Prodromidis, Kyprianos, 1999. "Unit roots and Granger causality in the EMS interest rates: the German Dominance Hypothesis revisited," Journal of International Money and Finance, Elsevier, vol. 18(1), pages 47-73, January. [Downloadable!] (restricted)
  3. Giavazzi, Francesco & Pagano, Marco, 1986. "The Advantages of Tying One's Hands: EMS Discipline and Central Bank Credibility," CEPR Discussion Papers 135, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  4. Bekaert, Geert & Hodrick, Robert J., 1993. "On biases in the measurement of foreign exchange risk premiums," Journal of International Money and Finance, Elsevier, vol. 12(2), pages 115-138, April. [Downloadable!] (restricted)
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  5. Katsimbris, George M & Miller, Stephen M, 1993. "Interest Rate Linkages within the European Monetary System: Further Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 25(4), pages 771-79, November. [Downloadable!] (restricted)
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  14. Jacobs, Rodney L & Leamer, Edward E & Ward, Michael P, 1979. "Difficulties with Testing for Causation," Economic Inquiry, Oxford University Press, vol. 17(3), pages 401-13, July.
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