Working Paper: CEPR ID: DP1783
Authors: Paul De Grauwe; Hans Dewachter; Dirk Veestraeten
Abstract: In this paper we solve a particular type of stochastic process switching problem where the terminal date is fixed but the terminal price may depend on past prices. We apply this framework to the effect of various conversion modalities currently discussed on exchange rate dynamics in the transition phase towards Stage III of EMU. The conclusions from our analysis may provide guidelines not only for the initial EMU members, but also for the countries that join at a later stage.
Keywords: stochastic process switching; EMU; conversion rates; Stage III
JEL Codes: F31; F33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Announcement of conversion modalities (Y20) | Exchange rate dynamics (F31) |
| Anticipated conversion rules (Y20) | Exchange rates (F31) |
| Chosen conversion rule (Y10) | Size of jump in exchange rates at announcement (F31) |
| Chosen conversion rule (Y10) | Subsequent volatility path (G17) |
| Conversion rule selected (Y10) | Different exchange rate responses (F31) |