Uncovered interest rate parity and analysis of monetary convergence of potential EMU accession countries

This paper analyzes deviations from uncovered interest rate parity which are interpreted as indicator of the substitutability of currencies. Backward recursive statistical tests and error correction models are applied to study the co-movement of interest rates, and rolling regressions are used to study size and volatility of country specific risk premiums. In accordance to their degree of monetary integration with the Euro area, new EU members and accession countries are divided into three groups. Estonia and Lithuania seem to exhibit the highest degree of monetary integration with the Euro area.I thank Carsten Trenkler, Jürgen Wolters and two anonymous referees for helpful comments. The paper has also benefited from discussions with participants of the joint econometrics seminar of Humboldt-Universität zu Berlin and Freie Universität Berlin and of the Econometric Society European Meeting 2004 in Madrid. Financial support from the Deutsche Forschungsgemeinschaft (SFB 373, TP C3) is gratefully acknowledged.