Implied exchange rate correlations and market perceptions of European Monetary Union

Quarterly Bulletin 1997 Q4
Published on 01 December 1997

By Creon Butler and Neil Cooper, of the Bank’s Monetary Instruments and Markets Division.

Most of techniques attempt to infer this information from interest rate differentials. Typically, they also require assumptions about the level of interest rates that would hold should a country not join EMU. This article discusses an alternative measure of EMU convergence—the expected correlation between currencies implicit in foreign exchange options prices. It shows how implied correlations may be calculated, and how they may be used to gauge expectations of EMU participation by continental European countries and to interpret sterling’s movements since mid 1996.

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