Risk Price after Euro's introduction

Abstract

This paper analyses the evolution of the risk premium of the peseta/dollar and pound sterling/dollar. For this purpose, we consider that the risk premiums are a function of the conditional covariance between two exchange rates, and that they can be separated into two components which vary through time: the price of risk and the conditional volatility. Daily frequency data have been used, covering the period from January 1 1996 to January 12 2001. The results show an increase of the risk premium for the peseta/dollar after the introduction of the euro, implying an increase of risk in the European Union area against the dollar. On the other hand, it is expected that the pound sterling appreciates against the peseta in the presence of expected depreciations of the peseta against the dollar in that period. Finally, it does not seem to be evidence of greater link of commom movements between the peseta and the pound sterling after the entrance of the euro.