Since when have FOREX markets incorporated EMU into currency pricing? Evidence from four exchange rate series

Recent theory on exchange rate dynamics suggests that the mere announcement of regime switching from floating to fixed rates at a given future date triggers a reduction in exchange rate volatility during the interim period. Using a Markov-switching GARCH model this paper estimates the volatility processes of four EMU exchange rate returns vis-?-vis the German mark using daily data for the time prior to Stage III of EMU. Statistical inference yields the dates at which financial markets began to incorporate the expected EMU participation of each country into currency pricing. The data exhibits strong econometric evidence for two distinct views concerning the ultimate EMU membership: (1) Finland and France were considered irrefutable EMU members long before any official announcements. (2) At first, the markets did not reckon with the participation of Italy and Portugal for a long time, but then suddenly reversed their assessment more or less at a stroke.