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 Examined Equity correlations We anticipate that a unified currency would increase equity return correlations, as countries’ economies become more integrated Examined FX Correlations Reviewed standard deviations between correlations from 1988–2000 for all countries in the euro zone to determine whether deviations decrease over time

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 1999-2001 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 Other factors affecting equity returns include; Intro costs associated with euro intro, systems upgrades, etc that might decrease company earnings Pricing pressure due to transparency within the integrated markets