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Currency Unification Impact on Equity Returns in the Euro Zone: A Study on Volatility Effects

This study delves into the effects of currency unification on equity market volatility and returns within the European Union, specifically focusing on the introduction of the Euro. Through a detailed methodology involving data collection, analysis, regressions, and forecasts, the study explores the relationships between currency volatility, equity returns, and other variables influencing the financial markets. The conclusion highlights the increasing correlation in Euro-Zone equity returns and the convergence of currency volatilities among member countries. Further analysis suggests that additional variables beyond currency fluctuations play a significant role in influencing equity returns, urging for a broader examination of factors like trade and market capitalization. While the Euro introduction was a significant step in economic unification, the study also indicates the need to explore potential FX convergence in other regions.

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Currency Unification Impact on Equity Returns in the Euro Zone: A Study on Volatility Effects

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  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

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