Extracting information from asset prices: the methodology of EMU calculators

Research output: Contribution to journalArticlepeer-review

Author(s)

Department/unit(s)

Publication details

JournalEuropean Economic Review
DatePublished - 2000
Volume44
Number of pages26
Pages (from-to)1607-1632
Original languageEnglish

Abstract

This paper develops a particular technique for extracting market expectations from asset prices. We use the term structure of interest rates to estimate the probability the market attaches to the event that a country, Italy, joins the European Monetary Union at a given date. The case of Italy is interesting because in the survey regularly conducted by Reuters, the probability that Italy joins EMU in 1999 has fluctuated, in the first months of 1997, between 0.07 and 0.15, while, during the same period, the measures computed by financial houses - which are based on the term structure of interest rates - ranged between 0.5 and 0.8. The paper proposes a new method for computing these probabilities, and shows that the discrepancies between survey and market-based measures are not the result of market inefficiencies, but depend on an incorrect use of the term structure to compute probabilities. The technique proposed in the paper can also be used to distinguish between convergence of probabilities and convergence of fundamentals, that is to find out whether an observed reduction in interest rate spreads signals a higher probability of joining EMU at a given date, or simply reflects improved fundamentals. It could also be applied, more generally, to extract from assets prices, information on imminent changes in an exchange rate regime.

    Research areas

  • Term structure of interest rates; Expectational model; Probabilities of entering EMU

Discover related content

Find related publications, people, projects, datasets and more using interactive charts.

View graph of relations