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ERM bandwidths for EMU and after: evidence from foreign exchange options


  • José B. Campa
  • P.H. Kevin Chang
  • Robert L. Reider


type="main" xml:lang="en"> Are the wide bands adopted in the summer of 1993 too large? The official answer is that wide bands offer a protection against speculative pressure, while exchange rates may be kept within narrower margins at the discretion of the authorities. Yet if exchange rate fixity and predictability are desirable, as implicitly assumed by the mere existence of the system, there must exist a trade-off between protection against speculative pressure and predictability. In that case, the bandwidth chosen should be as narrow as possible and yet unlikely to be challenged by the markets. This paper offers estimates of ‘safe’ bandwidths. For the long-term member currencies (French franc, peseta, Danish krone and escudo), the existing 15% bands are found to be unnecessarily wide: narrower 3.5% bands would capture at least 95% of expected exchange rate realizations over a three-month horizon. For the lira, Finnish markka and Swedish krone, wider bands of 5–6% would capture a similar amount of the exchange rate distribution. The pound's exchange rate expectations are the most dispersed, requiring 8.4% bands to capture 95% of exchange rate expectations.

Suggested Citation

  • José B. Campa & P.H. Kevin Chang & Robert L. Reider, 1997. "ERM bandwidths for EMU and after: evidence from foreign exchange options," Economic Policy, CEPR;CES;MSH, vol. 12(24), pages 53-89, April.
  • Handle: RePEc:bla:ecpoli:v:12:y:1997:i:24:p:53-89

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    References listed on IDEAS

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    Cited by:

    1. Roberto Casarin & Fabrizio Leisen & German Molina & Enrique ter Horst, 2014. "A Bayesian Beta Markov Random Field Calibration of the Term Structure of Implied Risk Neutral Densities," Papers 1409.1956,
    2. José Manuel Campa & P.H. Kevin Chang & James F. Refalo, 1999. "An Options-Based Analysis of Emerging Market Exchange Rate Expectations: Brazil's Real Plan, 1994-1997," Working Papers 99-08, New York University, Leonard N. Stern School of Business, Department of Economics.
    3. Jondeau, Eric & Rockinger, Michael, 2000. "Reading the smile: the message conveyed by methods which infer risk neutral densities," Journal of International Money and Finance, Elsevier, vol. 19(6), pages 885-915, December.
    4. Campa, Jose M. & Chang, P. H. Kevin & Refalo, James F., 2002. "An options-based analysis of emerging market exchange rate expectations: Brazil's Real Plan, 1994-1999," Journal of Development Economics, Elsevier, vol. 69(1), pages 227-253, October.
    5. Coutant, Sophie & Jondeau, Eric & Rockinger, Michael, 2001. "Reading PIBOR futures options smiles: The 1997 snap election," Journal of Banking & Finance, Elsevier, vol. 25(11), pages 1957-1987, November.
    6. Cho-Hoi Hui & Chi-Fai Lo & Tsz-Kin Chung, 2008. "Market Expectation of Appreciation of the Renminbi," Working Papers 0803, Hong Kong Monetary Authority.
    7. Dupont, Dominique Y., 2001. "Extracting Risk-Neutral Probability Distributions from Option Prices Using Trading Volume as a Filter," Economics Series 104, Institute for Advanced Studies.
    8. Campa, Jose M. & Chang, P. H. Kevin & Reider, Robert L., 1998. "Implied exchange rate distributions: evidence from OTC option markets1," Journal of International Money and Finance, Elsevier, vol. 17(1), pages 117-160, February.
    9. Vergote, Olivier & Puigvert Gutiérrez, Josep Maria, 2012. "Interest rate expectations and uncertainty during ECB Governing Council days: Evidence from intraday implied densities of 3-month EURIBOR," Journal of Banking & Finance, Elsevier, vol. 36(10), pages 2804-2823.
    10. Steven A. Weinberg, 2001. "Interpreting the volatility smile: an examination of the information content of option prices," International Finance Discussion Papers 706, Board of Governors of the Federal Reserve System (U.S.).
    11. repec:eee:apmaco:v:258:y:2015:i:c:p:372-387 is not listed on IDEAS
    12. Jose M. Campa & P.H. Kevin Chang & Robert L. Reider, 1997. "Implied Exchange Rate Distributions: Evidence from OTC Option Markets," NBER Working Papers 6179, National Bureau of Economic Research, Inc.
    13. Bates, David S., 1999. "Financial markets' assessments of EMU," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 51(1), pages 229-269, December.
    14. Bronka Rzepkowski, 2000. "The Expectations of Hong Kong Dollar Devaluation and Their Determinants," Working Papers 2000-04, CEPII research center.
    15. Marie Briere, 2006. "Market Reactions to Central Bank Communication Policies :Reading Interest Rate Options Smiles," Working Papers CEB 38, ULB -- Universite Libre de Bruxelles.
    16. David S. Bates, 1999. "Financial Markets' Assessment of EMU," NBER Working Papers 6874, National Bureau of Economic Research, Inc.

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