Stochastic Process Switching and Stage III of EMU

In this paper we solve a particular type of stochastic process switching problem where the terminal date is fixed but the terminal price may depend on past prices. We apply this framework to the effect of various conversion modalities currently discussed on exchange rate dynamics in the transition phase towards Stage III of EMU. The conclusions from our analysis may provide guidelines not only for the initial EMU members, but also for the countries that join at a later stage.