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Emu, Exchange Rate Volatility and Bid-Ask Spreads

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  • Nuno Cassola
  • Carlos Santos
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    Abstract

    This study deals with two issues related to the determination of exchange rate bid-ask spreads in the transition to EMU. First, we discuss how a credible announcement of conversion rates affects exchange rate volatility in the run up to the introduction of the Euro. Second, we discuss the theoretical relation that exists between exchange rate uncertainty and the bid-ask spread. The theory suggests that there is a positive association between exchange rate uncertainty and transaction costs and that we should observe a gradual reduction of exchange rate volatility in the transition to EMU. This theory implies a gradual shrinking of the bid-ask spread during the transition period. These conjectures are subject to empirical testing in the case of the exchange rate of the Portuguese escudo against the Deutsche Mark.

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    File URL: http://www.bportugal.pt/en-US/BdP%20Publications%20Research/WP199805.pdf
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    Bibliographic Info

    Paper provided by Banco de Portugal, Economics and Research Department in its series Working Papers with number w199805.

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    Date of creation: 1998
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    Handle: RePEc:ptu:wpaper:w199805

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    1. Gourieroux, C. & Monfort, A. & Trognon, A., 1985. "A General Approach to Serial Correlation," Econometric Theory, Cambridge University Press, vol. 1(03), pages 315-340, December.
    2. Paul Krugman & Marcus Miller, 1992. "Exchange Rate Targets and Currency Bands," NBER Books, National Bureau of Economic Research, Inc, number krug92-1, May.
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