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Explaining Recent European Exchange‐Rate Stability

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  • Paul De Grauwe
  • Hans Dewachter
  • Dirk Veestraeten

Abstract

In this paper we analyse the behaviour of the bilateral exchange rates that were converted into euros on 1 January 1999. Using a model of stochastic regime switching we study the effects of future conversion on current exchange‐rate dynamics. We find that exchange rates are to a large extent determined by the discounted (expected) conversion value. The theoretical model is subsequently applied to the currencies that participate in the first wave of the European Monetary Union (EMU). Using a Kalman approach, we find that for most currencies the weight attached to the future conversion value was well over 95%. This pricing characteristic successfully insulated intra‐European exchange rates from the turmoil generated by the ongoing crises in Asia, Russia and Latin America.

Suggested Citation

  • Paul De Grauwe & Hans Dewachter & Dirk Veestraeten, 1999. "Explaining Recent European Exchange‐Rate Stability," International Finance, Wiley Blackwell, vol. 2(1), pages 1-31, April.
    • Handle: RePEc:bla:intfin:v:2:y:1999:i:1:p:1-31
    DOI: 10.1111/1468-2362.00017
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    Cited by:

    1. Francisco Perez-Bermejo & Simon Sosvilla-Rivero & Reyes Maroto-Illera, 2007. "An eclectic approach to currency crises: drawing lessons from the EMS experience," Applied Financial Economics, Taylor & Francis Journals, vol. 18(6), pages 503-519.
    2. Anna Naszódi, 2007. "Are the Exchange Rates of EMU Candidate Countries Anchored by their Expected Euro Locking Rates?," Focus on European Economic Integration, Oesterreichische Nationalbank (Austrian Central Bank), issue 1, pages 115-134.
    3. Paul de Grauwe & Gunther Schnabl, 2004. "Nominal versus Real Convergence with Respect to EMU Accession.How to Cope with the Balassa-Samuelson Dilemma," EUI-RSCAS Working Papers 20, European University Institute (EUI), Robert Schuman Centre of Advanced Studies (RSCAS).
    4. S. Sosvilla-Rivero & R. Maroto-Illera, 2003. "Regimen changes and duration in the European Monetary System," Applied Economics, Taylor & Francis Journals, vol. 35(18), pages 1923-1933.
    5. Francisco Ledesma Rodríguez & Manuel Navarro Ibáñez & Jorge Pérez Rodríguez & Simón Sosvilla Rivero, 2008. "The Credibility of the European monetary System:A Review," Cuadernos de Economía - Spanish Journal of Economics and Finance, Asociación Cuadernos de Economía, vol. 31(86), pages 005-034, Mayo-Agos.
    6. Francisco Ledesma-Rodriguez & Manuel Navarro-Ibanez & Jorge Perez-Rodriguez & Simon Sosvilla-Rivero, 2005. "Assessing the credibility of a target zone: evidence from the EMS," Applied Economics, Taylor & Francis Journals, vol. 37(19), pages 2265-2287.
    7. Naszodi, Anna, 2010. "Testing the asset pricing model of exchange rates with survey data," Working Paper Series 1200, European Central Bank.
    8. Gunther Schnabl & Paul De Grauwe, 2004. "Nominal versus Real Convergence with Respect to EMU Accession - EMU Entry Scenarios for the New Member States," International Finance 0403008, University Library of Munich, Germany, revised 16 Feb 2005.
    9. Simón Sosvilla-Rivero & Francisco Pérez-Bermejo, "undated". "Credibility and Duration in Target Zones: Evidence from the EMS," Working Papers 2003-19, FEDEA.

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