Currency Unification: Foreign Exchange Volatility and Equity Returns

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

2. Agenda • Hypothesis • The Euro Zone • Methodology • Analysis • Conclusion • Further Analysis

3. 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

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

5. 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)

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

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

8. Methodology - Forecasts • Performed out of sample forecast for 1999-2001 samples • Calculated conditional volatility using ARCH

9. Analysis- FX

10. Analysis - Equity

11. Analysis - Regressions

12. 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

13. 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