Stochastic behaviour of Deutsche mark exchange rates within EMS

Abstract

This article explores the intertemporal interaction of three European Monetary System (EMS) exchange rates namely, the French franc, the Belgian franc, and the Italian lira vis-a-vis the Deutsche mark from 1979 to 1999. The returns were examined using the multivariate moving average Exponential GARCH model, which is capable of accounting for potential asymmetries in the volatility transmission mechanism. The results point to significant and reciprocal volatility spillovers among markets before Germany's reunification in 1990. However, absence of spillovers and/or asymmetric behaviour of volatility is shown in the post-unification period. The 1990s witnessed a rapid process of macroeconomic convergence by the core EMS members and these actions substantially enhanced confidence about full monetary integration. Put differently, the EMS countries became better attuned to the business cycle and managed to significantly reduce consequential asymmetric shocks and thus exchange rate volatility.