INTEREST-RATE CONVERGENCE, CAPITAL CONTROLS, RISK PREMIA AND FOREIGN-EXCHANGE MARKET-EFFICIENCY IN THE EMS

This paper examines interest rate convergence between Germany and the other EMS countries. We argue that earlier tests of convergence based on cointegration are not informative, because cointegration only impli es that a linear combination of interest rates is stationary. We show that a conclusive judgment about convergence can be made if interest r ate differentials exhibit a trend towards zero during the period when convergence occurred, and if the cointegrating vector has unit coeffic ients. We then establish that convergence has taken place in tile ''ha rd'' EMS period. We also attempt to identify the sources of nonstation arities in interest differentials by examining the existence of stocha stic or deterministic trends in the expected rate of depreciation and in the risk premium. Finally, the possibility of market inefficiencies is discussed.