Post-euro Periods Research Articles

European exchange rate regimes and purchasing power parity: An empirical study on eleven eurozone countries

It is widely believed that following the adoption of the euro, long run purchasing power parity (PPP) is more likely to hold within the euro countries. By applying the panel unit root test of Pesaran (2007) to real exchange rate data of eleven euro countries for the sample period of January 1957 to May 2013, we find that, contrary to the above intuition, the evidence for the mean-reverting in real exchange rates is much weaker in the post-1998 euro period than in the pre-euro period. In contrast, we find that for the four countries not using the euro: Norway, Sweden, Switzerland, and the UK, the evidence for the mean-reverting in real exchange rates is strong in both the pre- and post-euro (post-1998) periods. Moreover, through our panel estimation of the error correction model using the common correlated effects (CCE) estimators a la Pesaran (2006), we find that the flexibility of nominal exchange rates is crucial for the adjustment of real exchange rates to PPP.

Revisiting business cycles in the Eurozone: A fuzzy clustering and discriminant approach

The first part of analysis draws out homogenous clusters of countries out of the 27 EU states based on their business cycle synchronicities with the euro area (EA) 12, quantified by correlations of cycles between the 27 countries’ GDP components and the EA12’s GDP1. The purpose is to compare the obtained country groupings with the countries that have adopted the euro in practice. This exercise is performed using fuzzy cluster analysis and is carried out for pre- and post-euro periods. Knowing that the recent global and euro zone crisis might impact the post-euro findings, the analysis for the post-euro period is done with and without the crisis period. In the second part of the analysis, a discriminant technique is applied to the clustering findings to ascertain the GDP component whose cycle synchronicity contributes most to the partitioning obtained in the cluster analysis. In a nutshell, findings indicate a significant divergence within EU27 and EA12 in the post-euro period and that business cycle symmetry concerning the GDP component of capital investment as a more significant determinant to country partitions.

Clustering eurozone cycles

Firstly, the study draws out symmetrical subsets of 27 member countries of the European Union (EU27) countries according to their extents of business cycle symmetry with the whole of EA12, quantified by correlations of cycles between the countries’ GDP components and the EA12s GDP. The objective is to evaluate the obtained country groupings against the EA12 countries, the initial members of the euro club. This exercise is implemented using hierarchical cluster analysis for pre- and post-euro periods. As a robustness check, a principal component analysis is applied. Secondly, the analysis deploys a discriminant technique on the cluster analysis solutions to identify the GDP component whose cycle synchronicity contributes most to separation of the countries. In a nutshell, the findings suggest a significant rise in fragmentation within EU27 and within EA12 after euroization and that cycle synchronization involving the GDP component of private investment as a more important determinant to country classifications.

Exchange Rate Shocks and Firm Competitiveness in a Small, Export-Oriented Economy: The Case of Finland

This study empirically examines how exchange rate shocks affect firms’ competitiveness in the small, export-oriented country of Finland. Specifically, using Sweden as a benchmark and controlling for cross-country sector and industry effects, the forex competition hypothesis is tested using the impact of exchange rate shocks on Finnish stock returns. The empirical tests reveal statistically significant exchange rate exposure of Finnish stock returns. Comparing pre- versus post-euro periods, equities’ exchange rate exposure is much stronger after the introduction of the euro. Further results indicate that Finnish and Swedish sector and industry stock returns positively co-move. This implies market integration in contradiction to the forex competition hypothesis. However, for some sectors and industries interaction variables reveal that the co-movement is conditional on exchange rate movements, especially in the post-euro period.

House Price Comovements in the Eurozone Economies

1. Introduction International transmission of house price changes appears to be a natural corollary of an increasingly internationalized and interdependent financial environment. In addition, parallel movements in borrowing conditions and macroeconomic fundamentals are expected to strengthen the tendency of international house prices to comove. This should be particularly true in the case of the euro-zone, where the currency is common and monetary policy is conducted by the European Central Bank on behalf of all members. Since the mid-1990s, in particular, the housing prices of major European economies have been strongly increasing and this increase has been largely associated with high growth rates experienced over the last decade. However, recently such comovement has been blamed for triggering the latest global financial crisis. Housing as a non-traded good is not easily substituted among different countries. Over the last decade it has been claimed that major European countries' housing markets have been overvalued and that housing spillover effects appeared not only within an economy but also across economies. Two main differences stand out in the behavior of real assets like residential housing as opposed to financial markets assets like shares and bonds. First it is possible to use the information included in housing prices to make returns in excess of a buy and hold strategy i.e the efficient market hypothesis does not hold and second the housing prices are less flexible downwards compared with stocks. So the risk-return profile of an asset like residential housing makes it more attractive to investors. This paper sets out to investigate the factors underlying the apparent comovement of housing prices of the largest Euro zone economies. Specifically, we will examine first the relative importance of local factors (income, interest and stock prices) in explaining house price movements on a national level. Doing that, we differentiate between pre- and post-Euro periods and distinguish between economic expansions and contractions. We then look at the existence of spillover effects of shocks from both German monetary policy and volatility in its home housing market to the real house prices of the other countries in the Euro zone. Finally, we investigate the impact of global shocks such as emanating from changes in the US monetary policy on the volatility of each country's housing market. Using monthly data from DSI Statistical Bases for 1990(1)-2009(4), we investigate first whether there is overvaluation in real house prices across seven Euro zone economies. The economies examined namely Austria, Finland, France, Germany, Italy, the Netherlands, and Spain, constitute the core of the Euro zone, and are responsible for 90% of the zone's GDP and making up the second largest economy in the world after the US. Next, we concentrate on the impact of the adoption of the common currency on real house prices movements. We conduct the analysis using country-specific macroeconomic variables and then extend it by adding foreign-specific macro variables to each country's model. The empirical analysis includes cointegration analysis and VAR specifications. The rest of the paper is organized as follows: A brief survey of related literature is conducted in section 2. Section 3 presents stylized facts from each country's housing market. Section 4 outlines the methodology employed in the paper and includes the data description and variable selection. Section 5 presents and discusses the empirical findings. Concluding remarks are made in section 6. 2. Review of the Literature A number of studies have indicated comovement of house price changes, mainly attributed to synchronization of monetary policy, financial liberalization, integration of international financial markets, as well as global business cycle linkages (see, for example, Helbling and Terrones, 2003; Tsatsaronis and Zhu, 2004; Scanlon et al. …

Exchange rate and inflation risk premia in the EMU

This paper tests the effects of exchange rate and inflation risk factors on asset pricing in the European Union (EU) stock markets. This investigation was motivated by the results of Vassalou [J. Int. Money Finance, 2000, 19, 433–470] showing that both exchange rate and foreign inflation are generally priced in equity returns, and it studies the opportunity of evaluating the causality between these sources of risk after the elimination of the EU currency risks because of the adoption of the single currency. Our results show that both exchange rate and inflation risks are significantly priced in the pre- and post-euro periods. Moreover, the sizes of exchange rate and inflation risk premiums are economically significant in the pre- and post-euro periods. Futhermore, the UK and excluding-UK inflation risk premiums explain, in part, our evidence concerning a large EUR/GBP exchange rate risk premium and the existence of an economically significant domestic non-diversifiable risk after euro adoption. Hence overlooking inflation risk factors can produce an under/overestimation of the currency premiums and a miscalculation of the degree of integration of stock markets.

Equity Home Bias and the Euro

This paper examines explanations for the equity home bias puzzle by utilizing the introduction of the euro in 1999 as a natural experiment. The introduction of the euro and the coordination of monetary policy across the Euro Area (EA) allows for a closer examination of this puzzle. Optimal foreign equity shares are derived from a version of the CAP-M and then empirically tested using detailed data from the IMF's Coordinated Portfolio Investment Survey covering the foreign equity holdings of 23 countries for the years 1997 and 2001–2004. While equity home bias has fallen worldwide over this period, by far the sharpest drop has been for intra-EA equity holdings with home bias falling from 68% to 29% between the pre and post-euro periods. Several explanations for this drop are tested, with the reduction in information asymmetries emerging as the most promising candidate.

Exchange rate exposure in the pre- and post-Euro periods: evidence from Finland

This paper investigates asymmetric as well as first- and second-moment exchange rate exposure of the Finnish stock exchange (FSE) during the pre- and post-Euro periods. There is evidence of significant market-level and residual exchange rate exposure in the pre-Euro period. In the period, following the introduction of the Euro, however, exchange rate exposure becomes insignificant both at the market level and at the individual portfolio level with minor exceptions. Obviously, the introduction of the Euro has had a profound impact on the exchange rate exposure of the FSE.

Transition to the Euro and its impact on country portfolio diversification

By examining the impact of the introduction of the Euro on stock markets and on country diversification within the Eurozone, the evidence does not suggest a high risk to the stock market to justify a risk premium as a result of currency union. Although the Euro market integration has increased inter-country correlations, it does not preclude gains from international diversification, which partially rely on the non-Eurozone countries for an optimal portfolio in a mean-variance framework. Furthermore, the empirical evidence supports that there is a significant stationarity of average correlations over time between pre-Euro and post-Euro periods, and it has improved since the introduction of the Euro. Also, results show that the Euro produced a change in volatility with a different pace within the Eurozone vis-à-vis non-Eurozone countries, to support a direct and opposite relationship between volatility and correlation.

Exchange Rate Shocks and Firm Competitiveness in Small, Export-Oriented Economies

This study empirically examines how exchange rates affect firms’ stock returns in small, export-oriented countries that compete closely with one another. Specifically, controlling for cross-country sector and industry effects between Finland and Sweden, we test the impact of exchange rate shocks on Finnish stock returns. In general, empirical tests reveal statistically significant exchange rate exposure of Finnish stock prices. Comparing pre- versus post-euro periods, equities’ exchange rate exposure is much stronger after the introduction of the euro. Further results show that Finnish and Swedish sector and industry stock values positively co-move with another, which implies market integration as opposed to competitiveness. However, interaction variables reveal that their co-movement is conditional on exchange rate movements for some sectors and industries, especially in the post-euro period. We conclude that countries with small, open economies can be prone to exchange rate movements that (dis)advantage some firms relative to competing firms in other countries.

Prospects for the Euro: Will Reserve Holdings Shift in Its Favour?

The determinants of Central Bank reserve holdings of major hard currencies are analyzed for the pre-Euro and the post-Euro periods. Real economic variables, financial variables, and developments in key Asian markets which are likely to possess greater clout in the future are used in the estimation process. Developments in oil markets are also considered while evaluating the future global importance of the Euro. Simulations are undertaken to trace possible future scenarios for the Euro and the Dollar. The simulations indicate that a rise in Asian emerging market share of world output will work towards preserving Dollar dominance.

Price and volatility spillovers between exchange rates and stock indexes for the pre- and post-euro period

In this paper we explore the nature of the mean, volatility and causality transmission mechanism between stock and foreign exchange markets for the United States and some major European markets for the periods pre- and post-euro. The asymmetric volatility transmission is described by an extended Multivariate Exponential Generalized Autoregressive Conditionally Heteroskedastic (EGARCH) model. The results support the asymmetric and long-range persistence volatility spillover effect and show strong evidence of causality in the mean and variance between foreign exchange rate and stock price for both pre- and post-euro periods. However, the stock price has a more significant effect on foreign exchange rate for the two subsamples. These results are robust to the cross-correlation function test suggested by Cheung and Ng. The implication is particularly important for international portfolio managers when devising hedging and diversification strategies for their portfolios.

Equity Home Bias and the Euro

This paper examines explanations for the equity home bias puzzle by utilizing the introduction of the euro in 1999 as a natural experiment. Equity home bias is the observation that although investors could attain both lower risk and greater returns by increasing international diversification in their equity portfolios, they fail to do so. Currency risk, informational asymmetries, transaction costs, and investor sentiment have all been presented as explanations for the bias with varying degrees of success. The introduction of the euro and the coordination of monetary policy across the Euro Area (EA) allows for a closer examination of these potential explanations. Optimal foreign equity shares are derived from a version of the CAP-M and then empirically tested using detailed data from the IMF's Coordinated Portfolio Investment Survey covering the foreign equity holdings of 23 countries for the years 1997 and 2001-2004. The key results of this analysis are that while equity home bias has fallen worldwide over this period, by far the sharpest drop has been for intra-EA equity holdings with home bias falling from 68% to 29% between the pre and post-euro periods. Several explanations for this drop are tested, with the reduction in information asymmetries emerging as the most promising candidate.