Exchange rate volatility and the mixture of distribution hypothesis

This study sheds new light on the mixture of distribution hypothesis by means of a study of the weekly exchange rate volatility of the Norwegian krone. In line with other studies we find that the impact of information arrival on exchange rate volatility is positive and statistically significant, and that the hypothesis that an increase in the number of traders reduces exchange rate volatility is not supported. The novelties of our study consist in documenting that the positive impact of information arrival on volatility is relatively stable across three different exchange rate regimes, and in that the impact is relatively similar for both weekly volatility and weekly realised volatility. It is not given that the former should be the case since exchange rate stabilisation was actively pursued by the central bank in parts of the study period. We also report a case in which undesirable residual properties attained within traditional frameworks are easily removed by applying the log-transformation on volatilities.

Currency Regime and Monetary Autonomy. Empirical Evidence Using Recent and Global Data from 1990 to 2007

This paper analyzes the exchange rate regimes from the perspective of monetary independence. To be specific, using recent and global data, we examine the sensitivity of domestic interest rates to the international interest rate, by conducting co-integration tests and by estimating the adjustment speeds through error-correction model, for different de facto currency regimes and for different types of capital markets. Our estimation results basically support the traditional views of ‘impossible trinity’, as far as the cases with open capital markets are concerned. The floating regime shows the less sensitivity of domestic interest rates to the international interest rate than the fixed regime does, which implies some capacity for domestic monetary autonomy under the floating regime. The cases with closed capital markets, on the other hand, include the cases showing high sensitivity of interest rates in some emerging market economies, which might imply the ‘fear of floating’ hypothesis.     

Exchange rate regime classifications and exchange rate variability

It is well known that the exchange rate regime (ERR) declared to the IMF is often different from the actual regime. Several alternative schemes for de facto regime classification have been developed. In this article, we compare the ability of four popular schemes to track exchange rate variability (ERV). We find that the existing ERR classifications do not match well with the degree of ERV, especially for intermediate regimes. For instance, in the Levy-Yeyati and Sturzenegger (2003) coding, the intermediate regimes exhibit greater ERV than the floaters. On the other hand, for the Reinhart and Rogoff (2004) coding, the fixers show greater variability than some intermediates.     

Are Flexible Exchange Rate Regimes more Volatile? Panel GARCH Evidence for the G7 and Latin America

This paper investigates empirically the relationship between exchange rate (ER) regimes and volatility of real exchange rate depreciation (RERD), comparing the G7 and 17 Latin American (LA17) countries, during 1970–2010. We estimate a panel autoregressive model with generalized autoregressive conditional heteroskedasticity (GARCH) errors and regime‐specific effects on both the conditional mean and conditional variance. For the G7, we find that, relative to the fixed ER regime, only the freely floating regime shows higher RERD volatility; under the managed floating regime the RERD is equally volatile and under the crawling peg it is actually less volatile. Instead, in the case of the LA17, more flexible ER regimes are associated with more volatile RERD rates, with higher volatility under the managed floating regime than under the crawling peg and with extremely high volatility under the “freely falling” ER regime.     

Interest Rate Volatility Prior to Monetary Union under Alternative Pre-Switch Regimes

Abstract. The volatility of interest rates is relevant for many financial applications. Under realistic assumptions the term structure of interest rate differentials provides an important predictor of the term structure of interest rates. This paper derives the term structure of differentials in a situation in which two open economies plan to enter a monetary union in the future. Two systems of floating exchange rates prior to the union are considered, namely a free-float and a managed-float regime. The volatility processes of arbitrary-term differentials under the respective pre-switch arrangements are compared. The paper elaborates the singularity of extremely short-term (i.e. instantaneous) interest rates under extensive leaning-against-the-wind interventions and discusses policy issues.     

Real exchange rate volatility,financial crises and exchange rate regimes

This article examines real exchange rate (RER) volatility in 80 countries around the world, during the period 1970 to 2011. Two main questions are raised: are structural breaks in RER volatility related to changes in exchange rate regimes or financial crises? And do these two events affect the permanent and transitory components of RER volatility? To answer these, we employ two complementary procedures that consist in detecting structural breaks in the RER series and decomposing volatility into its permanent and transitory components. Our results suggest that structural breaks in RER volatility coincidence with financial crises and certain changes in nominal exchange rate regimes. Moreover, our findings confirm that RER volatility does increase with the global financial crises and detect that the more flexible the exchange rate regime, the higher the volatility of the RER using a de facto exchange rate classification.     

Fear of floating

This paper uses unique household survey data to investigate the expected effects of a switch from a fixed exchange rate regime to a floating exchange rate regime in Bulgaria during the global financial crisis. The data show that the public associated such a switch with a contraction of output, higher prices, a decline in exports, and an overall deterioration of economic welfare. These expectations fuelled a strong opposition to removing the fixed exchange rate. Thus, the survey data allow us to investigate why a switch from a fixed exchange rate to a floating exchange rate did not take place.     

The choice of exchange rate regime: An empirical analysis for transition economies*

We analyze the choice of exchange rate regimes of the 25 transition economies in Europe and the CIS after 1990. The empirical results show that the traditional Optimum Currency Area considerations provide relevant guidance for the regime choices in these countries. Moreover, regime choices are influenced by inflation rates, cumulative inflation differentials, and international reserves sufficiency. That is, macroeconomic stabilization and the ability to commit to exchange rate pegs also play important roles. Large government deficits have ambiguous effects; they increase the likelihood of moving from flexible to intermediate regimes as well as that of moving from fixed to intermediate ones.     

Fundamentals, the exchange rate and prospects for the current and future EU enlargements: evidence from Bulgaria, Croatia, Romania and Turkey

We analyze the link between macroeconomic fundamentals and exchange rate dynamics in two new and two potential EU member states: Bulgaria, Romania, Croatia, and Turkey. Given the different institutional settings of the exchange rate market in the countries of interest, we follow two different modelling strategies. For Romania and Turkey, we evaluate possible exchange rate misalignments based on a monetary model of exchange rate determination. In the case of Bulgaria and Croatia, with currency board and narrow-band peg arrangements against the euro, we discuss possible exit strategies and quantitatively assess the effects of the peg arrangements by means of simulation.

EXCHANGE RATE REGIME AND MONETARY POLICY INDEPENDENCE IN EAST ASIA

Abstract.  This paper investigates whether the choice of exchange rate regimes influences the sensitivity of domestic interest rates to international interest rates. We empirically analyse this issue in the context of East Asian economies by employing a regime switching model. We find that the sensitivity of local interest rates to international interest rates declined in Korea and Thailand after they adopted floating exchange rate regimes. We also find that Japan, with a floating exchange regime, has greater independence in monetary policy than a pegged economy such as Hong Kong. These empirical findings suggest that exchange rate flexibility provides greater monetary independence.     

Foreign interest rate shocks and exchange rate regimes in East Asia

Using a theoretical dynamic stochastic general equilibrium model and an empirical panel vector autoregression, we assess the transmission of foreign real interest rate shocks on the volatility of various key macroeconomic variables in nine small open economies in East Asia taking into account the role of exchange rate regimes. Both the theoretical and empirical findings confirm the hypothesis that flexible exchange rate may work as a shock absorber when the economy is hit by foreign real interest rate shocks. The findings suggest a clear trade-off between the volatility of real exchange rate and real output to foreign interest rate shocks, both the US and G7 real interest rates, where the responses of real output are mitigated in countries that have more flexible exchange rate regime.     

What to stabilize in the open economy*

We consider the question how “best” to maintain price‐level stability in an open economy, and evaluate three possible policy choices: (a) a constant money growth rate rule; (b) a fixed exchange rate; and (c) a policy of explicit commitment to a price‐level target. In each case we assume that policy is conducted by injecting reserves into or withdrawing reserves from the “banking system.” In evaluating the three regimes, we adopt the criterion that the “best” policy should leave the least scope for indeterminacy and “excessive” economic volatility. In a steady‐state equilibrium, the choice of regime is largely irrelevant; any steady‐state equilibrium under one regime can be duplicated by an appropriate choice of the “control” variable under any other regime. However, we show that the sets of equilibria under the three regimes are dramatically different. When all countries follow the policy of fixing a constant rate of money growth, there are no equilibria displaying endogenously arising volatility and there is no indeterminacy of equilibrium. Under a regime of fixed exchange rates, indeterminacies and endogenously arising fluctuations are impossible if and only if the country with the low “reserve‐to‐deposit” ratio is charged with maintaining the fixed rate. Finally, when one country targets the time path of its price level, under very weak conditions, there will be indeterminacy of equilibrium and endogenously arising volatility driven by expectations.     

Does Regime Choice Affect Exchange Rate Volatility-Economic Growth Link? An Application of Panel-VAR Approach

In recent years, numerous studies demonstrated that the effect of exchange rate regimes on economic growth is influenced by several factors. However, the literature rarely takes into account the possible costs associated with improving institutional quality on the choice of exchange systems and the analysis of the effects of shocks in the case of each type of regime. Throughout this research, we analyze the extent of bidirectional shocks according to each regime and compare the shock effects accordingly. The results show that the real exchange rate is less volatile and the shock effect is lower in countries that adopt a fixed exchange rate regime while the exchange rate is more volatile and the shock is higher in countries that adopt a flexible exchange rate regime. To show the effect and persistence of shocks, we carried out a Panel-VAR regression completed by impulse response functions, VAR decomposition and Granger causality tests for 20 countries adopting the first type of exchange regime compared with 20 countries practicing an alternative exchange rate regime in the period from 1996 to 2012.     

PRICE-BASED MEASUREMENT OF FINANCIAL GLOBALIZATION: A CROSS-COUNTRY STUDY OF INTEREST RATE PARITY

Abstract.   We characterize the relationship between ex post exchange rate depreciation and the interest differential for both developed and emerging market economies. The measured ex post uncovered interest differentials in terms of both levels and absolute values are then related to a set of variables that capture macroeconomic and policy conditions. We find that a wide diversity in the coefficient relating depreciations and interest differentials can be attributed to differences in inflation volatility, financial development, capital account openness, legal development and the nature of the exchange rate regimes. The robust results are mainly found in the emerging market country grouping.     

Exchange rate volatility–economic growth nexus in Uganda

The global financial crisis has disrupted trade and capital flows in most developing economies, resulting in an increased volatility of exchange rates. We develop an autoregressive distributed lag model to investigate the effect of exchange rate volatility on economic growth in Uganda. Using data spanning the period 1960–2011, we find that exchange rate volatility positively affects economic growth in Uganda in both the short run and the long run. However, in the short run, political instability negatively moderates the exchange rate volatility–economic growth nexus. These results are robust to alternative specifications of the economic growth model.     

Inflation,interest and exchange rates in the transition1

Central and Eastern European economies have made extraordinary progress in their trade and exchange regimes. Surprisingly, instant convertibility was established for a great variety of exchange rate regimes. In spite of diversity, all these countries have followed a common pattern: severe initial undervaluation - the cost of speed and unrestricted trade - followed by rapid real revaluation and incipient protectionism. Since 1994 in many cases an embarrass de richesse has appeared: high capital inflows which are either inflationary or costly to sterilize. A major cause of these flows - or at any rate of the high cost of sterilization - is the presence of significant interest rate differentials higher than required to cover the risk of devaluation. These are the necessary consequence of a policy of positive real interest rates and of real revaluation from excessively undervalued exchange rates. Lower interest rates are recommended, both to stem financial capital inflows and to reduce the cost of their sterilization.     

Modelling the impact of central bank intervention on exchange rate volatility under inflation targeting

This article empirically investigates the effect of central bank’s foreign exchange interventions on the level and volatility of the Uganda shilling/US dollar exchange rate (UGX/USD) under an inflation-targeting regime. Utilizing daily data spanning the period 1 September 2005, to 31 December 2015, we estimate a foreign exchange intervention model within a GARCH theoretic framework. Empirical results indicate that foreign exchange interventions have had mixed impact on the volatility of the exchange rate. We find that inflation targeting is capable of curbing temporary exchange rate shocks. Empirical results indicate that while order flow is capable of reducing exchange rate volatility, an increase in the operating target rate, the 7-day interbank rate tends to exacerbate exchange rate volatility. Our empirical results are robust to alternative model specifications. We argue that inflation targeting is an effective monetary policy tool for curbing exchange rate volatility.     

Exchange rate and Chinese outward FDI

Did the exchange rate (ER) regime change that was announced by the Chinese government in 2005 lead to an increased sensitivity of Chinese multinational companies (MNCs) to ER fluctuations? To answer this question our article considers the effect of ER level, volatility and expectation on the Chinese outward foreign direct investment (OFDI) activities in 119 countries for a period of 2003–2013. We find striking evidence that Chinese Renminbi appreciation has a negative impact on Chinese outward FDI flows, and both higher ER volatility and expected depreciation encourage Chinese outward FDI flows. We introduce two complementary effects that explain these findings: repatriation effect and mercantilist effect. In view of the recent debate about the growing importance of Chinese Renminbi in the international transactions we believe that our research results shed light on the possible impact of ER policies on Chinese MNCs behaviour and global FDI distribution.     

Interest expectations and exchange rates news

Using a new survey data set ofmatched exchange rate and interest rate expectations for eight currencies relative to the German mark, we examine empirically the relationship between exchange rate returns, news and risk premia. News on interest differentials enters significantly in equations for the difference between the spot rate and the lagged forward rate for the British pound, Japanese yen, Spanish peseta and the US dollar. An unexpected rise in the interest rate differential tends to strengthen the domestic exchange rate. For each of these currencies, we also find significant effects of our ex-ante measure of the risk premium. In addition, we investigate the effect of lagged interest rate differentials as proxy for the risk premium and find that they do not capture time-varying risk premia as is widely suggested in the literature, but probably capture a peso-problem, learning about a policy change, a market-inefficiency or a combination of these factors.     

Volatility trade-offs in exchange rate target zones

The volatility trade-offs (i.e. the negative relationships between exchange rate variability and the interest rate differential) exhibited in the Krugman [Krugman, P. (1991). Target zones and exchange rate dynamics. Quarterly Journal of Economics, 106, 669–682.] model depend on the assumption of uncovered interest rate parity (UIP). However, the bands for several economies in Latin America and Eastern Europe are substantially different from those within the European Monetary System (EMS), in that their parity relationship deviates from UIP and volatility trade-offs do not exist. This paper develops a graphical exposition and uses it to show that the degree of capital mobility may serve as a plausible vehicle to explain the empirical evidence found in Krugman's regime of exchange rate target zones. Based on a Fleming-type stochastic macro model, we find that when capital mobility is relatively low, exchange rate variability exhibits a positive relationship with the interest rate differential. This result can be regarded as a possible way of resolving the conflicting outcomes between Krugman's prediction and existing empirical observations.