The French-German Interest Rate Differential since German Unification: The Impact of the 1992 and 1993 EMS Crisis

The EMS crisis of 1992-1993, which resulted in the widening of the exchange rate bands, may have had some impact on the long-run structure of the system consisting of daily 1-month-Eurorates on German Mark, US-Dollar and French Franc. First, we find that both the US Eurorate and the German-French Eurorate differential are stationary over the December 1990 to December 1993 period, within a Gaussian VAR. Second, using GARCH-models to account for heteroskedasticity it is demonstrated that Gaussian models can induce a misleading interpretation of the linkages, namely about the effects of the American rate on the French one. In spite of the crisis and the changes in the ERM, the volatility parameters for the German-French interest rate differential are quite stable over the sample. This can be related to the observation that the July 1993 crisis is not linked to a specifically high volatility.