Studies on monetary convergence in Europe have reached mixed conclusions, raising questions about whether the European Monetary System failed to expedite convergence, or whether convergence requires redefining. A definition of convergence is explored that conditions monetary policy on factors affecting real exchange rates. Inflation rates have converged, while unconditional monetary policies have not. Once conditioning factors are considered, much of the gap between inflation and monetary convergence is explained. Differences inoutput trends do not explain the gap, while velocity variability does. (JEL F33)
This paper examines two stylized regularities in currency futures traded on the International Monetary Market. Short horizon returns (weekly and monthly) sampled over the period 1984-1994 exhibit significantly positive autocorrelations at moderate lags. The pattern of autocorrelations in returns is not radically affected when the sample is partitioned into two sub-periods around the 1987 market crash. The positive autocorrelation pattern implies that the increments in currency futures prices are not consistent with the random walk hypothesis. Instead, it is consistent with an investor's fads model, in which deviations in prices exhibit persistence for a long period. This process is characterized by positive autocorrelations in returns and a mean-averting behaviour in prices. A GARCH prediction model based on the fads process is explored in which the spot exchange rate serves as a proxy for the fundamental for the currency futures. Deviations in the basis (the difference of the log spot exchange rate and the log futures exchange rate) can significantly predict returns up to 36 months.
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