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Volatility regime-switching in European exchange rates prior to monetary unification

  • Wilfling, Bernd

Several theoretical models suggest that the mere announcement of entering a currency union in the future triggers instantaneous changes in exchange-rate volatility. First, this paper develops a Markov-switching framework by which, in fact, volatility regime-switching in foreign exchange rates can be detected for all currencies in the run-up to the European Monetary Union (EMU). Second, the paper attributes the currency-specific volatility regime-switches to decisive economic, institutional and political factors prior to EMU. All in all, the empirical results suggest that for future EMU accession countries volatility regime-switching models provide a useful tool for a broad range of financial applications (e.g. for the pricing of currency options or for the construction of EMU probability calculators).

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Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 28 (2009)
Issue (Month): 2 (March)
Pages: 240-270

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Handle: RePEc:eee:jimfin:v:28:y:2009:i:2:p:240-270
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  19. Kim, Chang-Jin, 1994. "Dynamic linear models with Markov-switching," Journal of Econometrics, Elsevier, vol. 60(1-2), pages 1-22.
  20. Hamilton, James D., 1988. "Rational-expectations econometric analysis of changes in regime : An investigation of the term structure of interest rates," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 385-423.
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  22. Bollerslev, Tim & Chou, Ray Y. & Kroner, Kenneth F., 1992. "ARCH modeling in finance : A review of the theory and empirical evidence," Journal of Econometrics, Elsevier, vol. 52(1-2), pages 5-59.
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  24. Bergman, U. Michael & Hansson, Jesper, 2005. "Real exchange rates and switching regimes," Journal of International Money and Finance, Elsevier, vol. 24(1), pages 121-138, February.
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