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Currency Networks, Bilateral Exchange Rate Volatility and the Role of the US Dollar

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  • Michael Bleaney

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  • Mo Tian
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Abstract

We investigate monthly bilateral exchange rate volatility for a large sample of currency pairs over the period 1999–2006. Pegs (particularly to the US dollar) and managed floats tend to have lower volatility than independent floats. A deeper investigation shows that the peg effect operates almost entirely through currency networks (i.e. where two currencies are pegged to the same anchor currency), and the lower volatility of US dollar pegs reflects the size of the US dollar network. Managed floats show clear evidence of tracking the US dollar, further increasing the effective size of the US dollar network. Inflation undermines the currency-stabilizing effect of peg networks. Currencies in smaller peg networks have higher unweighted but not trade-weighted exchange rate volatility, which is consistent with anchors being chosen to minimize trade-weighted volatility. The size of the effective US dollar network revealed here is a plausible explanation of the rarity of basket pegs. Volatility also reflects a range of structural factors such as country size, level of development, population density, inflation differentials and business cycle asymmetry. Copyright Springer Science+Business Media, LLC 2012

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File URL: http://hdl.handle.net/10.1007/s11079-011-9229-x
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Bibliographic Info

Article provided by Springer in its journal Open Economies Review.

Volume (Year): 23 (2012)
Issue (Month): 5 (November)
Pages: 785-803

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Handle: RePEc:kap:openec:v:23:y:2012:i:5:p:785-803

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Web page: http://www.springerlink.com/link.asp?id=100323

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Keywords: Exchange rate volatility; Currency peg; Inflation; F3;

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  1. Guillermo A. Calvo & Carmen M. Reinhart, 2000. "Fear of Floating," NBER Working Papers 7993, National Bureau of Economic Research, Inc.
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  8. Reinhart, Carmen & Rogoff, Kenneth, 2004. "The modern history of exchange rate arrangements: A reinterpretation," MPRA Paper 14070, University Library of Munich, Germany.
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  16. repec:ebl:ecbull:v:6:y:2007:i:3:p:1-16 is not listed on IDEAS
  17. Michael Bleaney & Manuela Francisco, 2005. "Exchange rate regimes and inflation: only hard pegs make a difference," Canadian Journal of Economics, Canadian Economics Association, vol. 38(4), pages 1453-1471, November.
  18. Claudio Bravo-Ortega AND Julian di Giovanni, 2004. "Trade Costs and Real Exchange Rate Volatility," Econometric Society 2004 Latin American Meetings 227, Econometric Society.
  19. Michael Bleaney & Manuela Francisco, 2007. "Classifying exchange rate regimes: a statistical analysis of alternative methods," Economics Bulletin, AccessEcon, vol. 6(3), pages 1-16.
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