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Political and institutional factors in regime change in the ERM: An application of duration analysis

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  • Simón Sosvilla-Rivero

    (FEDEA and Universidad Complutense de Madrid)

  • Francisco Pérez-Bermejo

    (KPMG-Spain)

Abstract

This paper analyses the functioning of the European Exchange Rate Mechanism (ERM). To that end, we apply duration models to estimate an augmented target-zone model, explicitly incorporating political and institutional factors into the explanation of European exchange rate policies. The estimations are based on quarterly data of eight currencies participating in the ERM, covering the complete history of the European Monetary System. Our results suggest that both economic and political factors are important determinants of the ERM currency policies. Concerning economic factors, the money supply, the real exchange rate, the interest in Germany and the central parity deviation would have negatively affected the duration of a given central parity, while credibility and the price level in Germany would have positively influenced such duration. Regarding political variables, elections, central bank independence and left-wing administrations would have increased the probability of maintaining the current regime, while unstable governments would have been associated with more frequent regime changes. Moreover, we show how the political augmented model outperforms, both in terms of explanatory power and goodness of fit, the model which just incorporates pure economic determinants.

Suggested Citation

  • Simón Sosvilla-Rivero & Francisco Pérez-Bermejo, 2007. "Political and institutional factors in regime change in the ERM: An application of duration analysis," Working Papers 07-05, Asociación Española de Economía y Finanzas Internacionales.
  • Handle: RePEc:aee:wpaper:0705
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    References listed on IDEAS

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    Cited by:

    1. Eichler, Stefan, 2014. "The political determinants of sovereign bond yield spreads," Journal of International Money and Finance, Elsevier, vol. 46(C), pages 82-103.

    More about this item

    Keywords

    Duration analysis; political variables; exchange rates; European Monetary System;

    JEL classification:

    • C41 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Duration Analysis; Optimal Timing Strategies
    • D72 - Microeconomics - - Analysis of Collective Decision-Making - - - Political Processes: Rent-seeking, Lobbying, Elections, Legislatures, and Voting Behavior
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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