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Financial contagion, interest rates and the role of the exchange rate as shock absorber in Central and Eastern Europe

Maurizio Michael Habib
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Maurizio Michael Habib: University of Rome “La Sapienza”

International Finance from University Library of Munich, Germany

Abstract: This paper studies the impact of external factors on daily exchange rates and short-term interest rates in the Czech Republic, Hungary and Poland during the period August 1997 – May 2001. I find that neither exchange rates nor interest rates are influenced by short-term German interest rates. Nevertheless, I show that shocks to emerging-market risk premia had a significant impact on exchange rates in all three Central and Eastern European count-ries and on interest rates in the Czech Republic. In addition, studying the second moment of the variables, I demonstrate that Czech and Polish exchange rates were affected by ‘vo- latility contagion’ coming from emerging markets. I find also some partial support for the ‘volatility contagion’ hypothesis on Czech interest rates. These findings shed some doubts on the alleged theoretical ability of a floating exchange rate – such as in the Czech Repub-lic – to absorb external shocks and insulate a country's domestic monetary policy comple-tely. However, the spill-over effect on Czech interest rates might be explained by the ‘ma-naged’ nature of the exchange rate regime, thereby re-establishing some credibility of the theory.

Keywords: exchange rates; short-term interest rates; volatility; the Czech Republic; Hungary; Poland (search for similar items in EconPapers)
JEL-codes: L11 C81 F49 R38 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-fin, nep-ifn and nep-rmg
Date: 2002-09-20
Note: Type of Document - pdf; prepared on PC; pages: 46; figures: included
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