Exchange rate expectations and risk premia in the European Monetary System: 1985–1991

Stefano Cavaglia, Kees Koedijk and Peter Vlaar ()

Open Economies Review, 1994, vol. 5, issue 4, 347-360

Abstract: Using a new set of survey data on EMS exchange rates, we investigate exchange rate expectations and risk premia between December 1985 and August 1991 to assess credibility of the system. It appears that the EMS—with the exception of the Italian lira—had become credible since early 1990. Moreover, one of the core predictions of the target zone literature—the inverse correlation between the position of the spot rate in the fluctuation band with its expected change—is corroborated for several currencies in the period after April 1990. Although the system appeared to be more credible, the persistence of interest differentials suggested the existence of risk premia. For four out of six currencies we find a significant relationship between the risk premium and the inflation differential relative to Germany. Copyright Kluwer Academic Publishers 1994

Keywords: EMS expectations; credibility; risk premia (search for similar items in EconPapers)
Date: 1994
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DOI: 10.1007/BF01000719

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