Estimating exchange rate dynamics with diffusion processes: an application to Greek EMU data

Trede Mark, Wilfling Bernd

Abstract
Recently various exchange rate models capturing the dynamics during the transition from an exchange rate arrangement of floating rates into a currency union have been derived. Technically, these stochastic equilibrium models are diffusion processeswhich have to be estimated by discretely sampled observations.Using daily exchange rate data prior to theGreek EMU-entrance on 1 January 2001, we develop a rigorous estimation procedure. Our estimates point to an increasing interventionist economic policy in the run-up to the Greek EMU entrance.Acomparison of this econometric indication with policy information provided (ex-post) by the Bank of Greece (BoG) in its Annual Report 2000 reveals that the BoG indeed pursued such an active policy stance (so-called institutional frontloading strategies).

Keywords
Diffusion processes; estimation; exchange rates; EMU; institutional frontloading