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Interest Rate Volatility Prior to Monetary Union under Alternative Pre‐Switch Regimes

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  • Bernd Wilfling

Abstract

. The volatility of interest rates is relevant for many financial applications. Under realistic assumptions the term structure of interest rate differentials provides an important predictor of the term structure of interest rates. This paper derives the term structure of differentials in a situation in which two open economies plan to enter a monetary union in the future. Two systems of floating exchange rates prior to the union are considered, namely a free‐float and a managed‐float regime. The volatility processes of arbitrary‐term differentials under the respective pre‐switch arrangements are compared. The paper elaborates the singularity of extremely short‐term (i.e. instantaneous) interest rates under extensive leaning‐against‐the‐wind interventions and discusses policy issues.

Suggested Citation

  • Bernd Wilfling, 2003. "Interest Rate Volatility Prior to Monetary Union under Alternative Pre‐Switch Regimes," German Economic Review, Verein für Socialpolitik, vol. 4(4), pages 433-457, November.
  • Handle: RePEc:bla:germec:v:4:y:2003:i:4:p:433-457
    DOI: 10.1111/j.1465-6485.2003.00088.x
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    More about this item

    JEL classification:

    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection

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