Common Volatility Trends among Central and Eastern European Currencies

For the 12 new member states of the European Union, adopting the euro as the national currency some time in the next few years is not optional, as it was for the first 15 member states of the EU; it is a definite requirement which they eventually have to meet. This raises numerous questions regarding whether the economies in these countries are strong enough and sufficiently prepared for such an important step. While most of the papers on the subject deal with business cycle convergence, we focus on the common volatility trends among Central and Eastern European (CEE) currencies. We compare the long-run as well as short run volatility components and measure the intensity of volatility spillovers for each component. We also examine the evolution of conditional correlations, estimated from a multivariate GARCH model. Consistent with existing literature, our results suggest stronger linkages between the five currencies under analysis, although less strong than had previously been found for major European currencies. From the optimum currency area perspective, this would be a positive conclusion, but at the same time we believe it raises more problems for the policy makers of each country, as they have to increasingly take into account the actions of the other countries when making their own decisions. This calls for coordinated courses of action, which would be a very good exercise in preparation for euro adoption and a single, unified monetary policy.