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Liberalized Markets Have More Stable Exchange Rates

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  • Ales Bulir

Abstract

The paper looks at the hypothesis that financial market liberalization can create a basis for more stable exchange rates, as deviations of exchange rates from equilibrium levels bring forth stabilizing flows of liquidity. This "endogenous liquidity" hypothesis suggests that opening financial markets militates in favor of exchange rate flexibility by increasing the viability of a floating regime, as well as making it more difficult to maintain a peg. The paper examines this hypothesis in a sample of four transition economies and finds that exchange rates tend to return faster to their Hodrick-Prescott-based values where markets are liberalized. The results suggest that early and successful foreign exchange liberalization pays off in terms of depth of the market and, hence, faster adjustment of exchange rate to shocks. Moreover, it implies that central banks should not be overly concerned with short-run volatility of their national exchange rates, given the self-correcting tendencies.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 04/35.

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Length: 32
Date of creation: 01 Feb 2004
Date of revision:
Handle: RePEc:imf:imfwpa:04/35

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Related research

Keywords: Exchange rates; Markets; Transition economies; Economic models; exchange rate; foreign exchange; random walk; kurtosis; autocorrelation; standard errors; equation; foreign exchange market; statistics; exchange rate volatility; exchange rate determination; skewness; foreign exchange markets; exchange rate arrangements; significance level; exchange markets; euro exchange rates; exchange rate regimes; samples; forecasting; euro exchange rate; statistic; exchange rate developments; exchange rate data; daily exchange rate; stable exchange rates; exchange rate arrangement; time series; nominal exchange rate; empirical model; exchange rate dynamics; real exchange rate; outlier; nonlinearity; correlation; explanatory power; standard deviation; cointegration; normal distributions; sample mean; bilateral exchange rate; exchange rate flexibility; mean square; floating exchange rates; exchange rate shock; market exchange rates; currency units; history of exchange rate; logarithms; exchange rate shocks; exchange rate fluctuations; exchange rate movements; outliers; maximum likelihood estimation; dollar exchange rate; exchange rate regime; central tendency; daily exchange rates; exchange rate adjustment; exchange rate path; real exchange rate appreciation; equations; exchange rate appreciation; probability; correlations; flexible ? exchange rates; exchange rate movement; exchange rate risk; exchange rate variability;

References

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  1. Kobor, Adam & Szekely, Istvan P., 2004. "Foreign exchange market volatility in EU accession countries in the run-up to Euro adoption: weathering uncharted waters," Economic Systems, Elsevier, vol. 28(4), pages 337-352, December.
  2. Carmen M. Reinhart & Kenneth S. Rogoff, 2002. "The Modern History of Exchange Rate Arrangements: A Reinterpretation," NBER Working Papers 8963, National Bureau of Economic Research, Inc.
  3. István P. Székely & Ãdám Kóbor, 2004. "Foreign Exchange Market Volatility in Eu Accession Countries in the Run-Up to Euro Adoption," IMF Working Papers 04/16, International Monetary Fund.
  4. Martin D. D. Evans and Richard K. Lyons., 1999. "Order Flow and Exchange Rate Dynamics," Research Program in Finance Working Papers RPF-288, University of California at Berkeley.
  5. Beine, Michel & Laurent, Sebastien & Lecourt, Christelle, 2003. "Official central bank interventions and exchange rate volatility: Evidence from a regime-switching analysis," European Economic Review, Elsevier, vol. 47(5), pages 891-911, October.
  6. Michael B. Devereux & Philip R. Lane, 2002. "Understanding Bilateral Exchange Rate Volatility," Trinity Economics Papers 200211, Trinity College Dublin, Department of Economics.
  7. Bofinger, Peter & Wollmershäuser, Timo, 2001. "Managed floating: Understanding the new international monetary order," W.E.P. - Würzburg Economic Papers 30, University of Würzburg, Chair for Monetary Policy and International Economics.
  8. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
  9. Cogley, Timothy & Nason, James M., 1995. "Effects of the Hodrick-Prescott filter on trend and difference stationary time series Implications for business cycle research," Journal of Economic Dynamics and Control, Elsevier, vol. 19(1-2), pages 253-278.
  10. Merton, Robert C, 1987. " A Simple Model of Capital Market Equilibrium with Incomplete Information," Journal of Finance, American Finance Association, vol. 42(3), pages 483-510, July.
  11. Darvas, Zsolt & Szapary, Gyorgy, 2000. "Financial Contagion in Five Small Open Economies: Does the Exchange Rate Regime Really Matter?," International Finance, Wiley Blackwell, vol. 3(1), pages 25-51, April.
  12. Philippe Bacchetta & Eric van Wincoop, 2003. "Can Information Heterogeneity Explain the Exchange Rate Determination Puzzle?," Working Papers 03.02, Swiss National Bank, Study Center Gerzensee.
  13. repec:cup:macdyn:v:1:y:1997:i:3:p:640-57 is not listed on IDEAS
  14. Alexis Derviz, 2003. "Components of the Czech Koruna Risk Premium in a Multiple-Dealer FX Market," Working Papers 2003/04, Czech National Bank, Research Department.
  15. Kim, Soyoung, 2003. "Monetary policy, foreign exchange intervention, and the exchange rate in a unifying framework," Journal of International Economics, Elsevier, vol. 60(2), pages 355-386, August.
  16. Lucio Sarno, 2003. "Nonlinear Exchange Rate Models: A Selective Overview," Rivista di Politica Economica, SIPI Spa, vol. 93(4), pages 3-46, July-Augu.
  17. Lucio Sarno, 2003. "Nonlinear Exchange Rate Models," IMF Working Papers 03/111, International Monetary Fund.
  18. Siklos, P.L. & Granger, C.W.J., 1997. "Regime Sensitive Cointegration with an Application to Interest rate Parity," Working Papers 97-5, Wilfrid Laurier University, Department of Economics.
  19. Siklos, P.L. & Granger, C.W.J., 1997. "Regime Sensitive Cointegration with an Application to Interest rate Parity," Working Papers 97-5, Wilfrid Laurier University, Department of Economics.
  20. Hamid Faruqee & Lee Redding, 1999. "Endogenous Liquidity Providers and Exchange Rate Dynamics," Canadian Journal of Economics, Canadian Economics Association, vol. 32(4), pages 976-994, August.
  21. Helmut Stix, 2002. "Does Central Bank Intervention Influence the Probability of a Speculative Attack? Evidence from the EMS," Working Papers 80, Oesterreichische Nationalbank (Austrian Central Bank).
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Cited by:
  1. Gilda Fernandez & Cem Karacadag & Rupa Duttagupta, 2004. "From Fixed to Float," IMF Working Papers 04/126, International Monetary Fund.

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