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
The Euro Zone

• Austria
• Belgium
• Finland
• France
• Germany
• Greece

• Ireland
• Italy
• Luxembourg
• Netherlands
• Portugal
• Spain

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