French-German Interest Rate Differentials and Time-Varying Realignment Risk

January 1, 1993

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Format: Chicago

Francesco Caramazza. French-German Interest Rate Differentials and Time-Varying Realignment Risk, (USA: International Monetary Fund, 1993) accessed November 21, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This paper explores the determinants of expected rates of realignment of the French franc/Deutsche mark exchange rate during the period 1987-1991. It does so by first estimating expected parity changes and then relating these to economic variables that are believed to influence agents’ realignment expectations. Time-varying expected rates of realignment are estimated in two ways: one, by adjusting short-term euromarket interest rate differentials for the expected rate of change of the FF/DM exchange rate within the EMS fluctuation band and two, by the differential in the yield on long-term government bonds. The behavior of the exchange rate within the band is found to be consistent with mean reversion and the expected change is nontrivial. Thus, by filtering out the expected mean reversion within the band from short-term interest rate differentials more precise measures of expected changes in the central parity are obtained. Realignment expectations are found to be closely related to the evolution of fundamental economic variables and, for shorter horizons, the position of the franc in the fluctuation band.

Subject: Crawling peg, Currencies, Exchange rate adjustments, Exchange rates, Foreign exchange, Labor, Money, Unemployment rate

Keywords: Crawling peg, Currencies, Deutsche mark rate, Devaluation expectation, DM exchange rate, Euro-deutsche mark interest rates, Euromarket rate, Exchange rate adjustments, Exchange rate band, Exchange rates, Interest rate differential, Risk premium, Unemployment rate, WP

Publication Details

Pages:

28
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 1993/001
Stock No:

WPIEA0011993
ISBN:

9781451931334
ISSN:

1018-5941

Notes

Explores the determinants of expected rates of realignment of the French franc/Deutsche mark exchange rate during the period 1987-1991. Also published in Staff Papers, Vol. 40, No. 3, September 1993.

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