Currency Unification Foreign Exchange Volatility and Equity Returns

Currency Unification: Foreign Exchange Volatility and Equity Returns A study of the European Union and the effects of the Euro

Agenda Hypothesis The Euro Zone Methodology Analysis Conclusion Further Analysis

Hypothesis A unified currency within a region of countries will reduce currency volatility This should decrease equity market volatility As a result lower equity returns

The Euro Zone Austria Belgium Finland France Germany Greece Ireland Italy Luxembourg Netherlands Portugal Spain

Methodology – Obtaining Data Daily currency exchange rates (1970 - 2001) Calculated an average monthly standard deviation of FX rates (proxy for volatility based on daily data) Monthly equity index returns (MSCI local currency)

Methodology – Testing Examined equity return correlations Examined FX correlations Regressed exchange rate deviations (with $US) against local equity returns

Methodology – Perform Regressions Regressed FX std deviations against local returns Performed raw direction count • Metrics used – Eurodollar interest rate, world equity returns

Methodology - Forecasts Performed out of sample forecast for 19992001 samples Calculated conditional volatility using ARCH

Analysis- FX

Analysis - Equity

Analysis - Regressions

Conclusion Increasing correlation between Euro-Zone equity Returns Convergence in currency volatilities among countries within the euro zone leading up to ccy unification Unable to prove a robust relation on equity returns with our regressions Perhaps need more variables

Further Analysis Equity returns are affected by a number of factors, not solely currency fluctuations Identify other variables eg. Trade, mkt cap etc. Euro introduction was not a distinct radical step in the process of economic unification, the EU has been integrated for years Identify other regions in which FX convergence might occur