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Emu, Exchange Rate Volatility and Bid-Ask Spreads

Authors 
Nuno Cassola
Publication Year 
1998
JEL Code 
C25 - Discrete Regression and Qualitative Choice Models
F31 - Foreign Exchange
F36 - Financial Aspects of Economic Integration
Abstract 
This study deals with two issues related to the determination of exchange rate bid-ask spreads in the transition to EMU. First, we discuss how a credible announcement of conversion rates affects exchange rate volatility in the run up to the introduction of the Euro. Second, we discuss the theoretical relation that exists between exchange rate uncertainty and the bid-ask spread. The theory suggests that there is a positive association between exchange rate uncertainty and transaction costs and that we should observe a gradual reduction of exchange rate volatility in the transition to EMU. This theory implies a gradual shrinking of the bid-ask spread during the transition period. These conjectures are subject to empirical testing in the case of the exchange rate of the Portuguese escudo against the Deutsche Mark.
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