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Financial contagion, interest rates and the role of the exchange rate as shock absorber in Central and Eastern Europe

  • Maurizio Michael Habib

    (University of Rome “La Sapienza”)

Registered author(s):

    This paper studies the impact of external factors on daily exchange rates and short-term interest rates in the Czech Republic, Hungary and Poland during the period August 1997 – May 2001. I find that neither exchange rates nor interest rates are influenced by short-term German interest rates. Nevertheless, I show that shocks to emerging-market risk premia had a significant impact on exchange rates in all three Central and Eastern European count-ries and on interest rates in the Czech Republic. In addition, studying the second moment of the variables, I demonstrate that Czech and Polish exchange rates were affected by ‘vo- latility contagion’ coming from emerging markets. I find also some partial support for the ‘volatility contagion’ hypothesis on Czech interest rates. These findings shed some doubts on the alleged theoretical ability of a floating exchange rate – such as in the Czech Repub-lic – to absorb external shocks and insulate a country's domestic monetary policy comple-tely. However, the spill-over effect on Czech interest rates might be explained by the ‘ma-naged’ nature of the exchange rate regime, thereby re-establishing some credibility of the theory.

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    File URL: http://128.118.178.162/eps/if/papers/0209/0209004.pdf
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    Paper provided by EconWPA in its series International Finance with number 0209004.

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    Length: 46 pages
    Date of creation: 20 Sep 2002
    Date of revision:
    Handle: RePEc:wpa:wuwpif:0209004
    Note: Type of Document - pdf; prepared on PC; pages: 46; figures: included
    Contact details of provider: Web page: http://128.118.178.162

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