Abstract
We study whether foreign exchange market investors perceive the risk that vulnerable countries, such as Greece, Ireland, Italy, Portugal, or Spain, could leave the EMU to cope with the financial turmoil produced by the financial crisis in the eurozone. We find that since the aggravation of the financial crisis, after the collapse of Lehman Brothers in September 2008, the euro depreciates against the U.S. dollar when the incentive for vulnerable countries to leave the EMU is increased, i.e. when sovereign default risk increases (i.e. if sovereign credit default swap (CDS) spreads rise) and when bank crisis risk increases (i.e. if banks’ CDS premiums rise).
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Notes
- 1.
Art. 50(1) of the Treaty of Lisbon specifies that a withdrawal agreement must be made that defines a member’s “future relationship with the Union.” This suggests that a country may leave the EMU and can remain a EU member (Dougan 2008). Art. 50(3) of the Treaty of Lisbon even provides for automatic withdrawal in the case that a withdrawal agreement between the remaining EMU members and the withdrawing member fails.
- 2.
A rising exchange rate indicates an appreciation of the euro against the U.S. dollar.
- 3.
- 4.
The critical values for the test statistic \( \widehat{F}(k) \) can be found in Bekaert et al. (2002, pp. 244–245).
- 5.
Before estimating the models we check for unit roots in the variables for the pre-crisis and the crisis period. The results of the unit root tests are reported in Table 5 in the Appendix. All variables contain unit roots in levels and are therefore used in first differences, except for the euro and U.S. dollar interest rates which are stationary in levels during the crisis period. However, to make the results of the crisis-period comparable to the results of the pre-crisis period, we also use the interest rates in first differences in the crisis regime regression. As a robustness check we use the interest rates in levels in the crisis regression but the results (which are available upon request) change only marginally.
- 6.
- 7.
Please note that the observation period for Greece spans only from September 22, 2009 to March 1, 2010 since data on CDS premiums of Greek banks are only available from September 22, 2009.
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Eichler, S. (2013). The Risk of Withdrawals from the EMU and the Foreign Exchange Market. In: Maltritz, D., Berlemann, M. (eds) Financial Crises, Sovereign Risk and the Role of Institutions. Springer, Cham. https://doi.org/10.1007/978-3-319-03104-0_9
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