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

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 processes which have to be estimated by discretely sampled observations. Using daily exchange rate data prior to the Greek 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. A comparison 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).