Confidence Building on Euro Convergence: Theory and Evidence from Currency Options

@inproceedings{Driessen2003ConfidenceBO,
  title={Confidence Building on Euro Convergence: Theory and Evidence from Currency Options},
  author={Joost Driessen and Enrico C. Perotti},
  year={2003}
}
Using a new dataset of currency option prices, we study the evolution of investor confidence in 1992-1998 over the chance of individual currencies to converge to the Euro. Convergence risk, which may reflect uncertainty over policy commitment as well as exogenous fundamentals, induces a level of implied volatility in excess of actual volatility (volatility wedge). We show formally that confidence grows over time as convergence policy is maintained, and the risk of a reversal is progressively… CONTINUE READING

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